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Monitoring Your Portfolio’s Dollar Sensitivity

By Tripp Zimmerman At WisdomTree, we continue to believe one of the most important themes impacting the global markets has been the strengthening U.S. dollar-and this is a trend we expect to continue for some time. As a result of the recent dollar strength, many U.S. multinationals with global revenue streams have reported currency headwinds as part of their earnings statements over the past year. This has hurt their performance compared to European and Japanese exporters, who have benefited from the weakening of the yen and the euro, respectively, against the U.S. dollar. This relative performance advantage is no surprise to us, because our research shows that these foreign markets actually performed better when their home currencies depreciated than when they appreciated. 1 Given this historical relationship and relative valuations, we continue to advocate for Japanese and eurozone exporters. But how should investors position their U.S. allocations? U.S. Corporations Continue to Warn about Dollar Strength “Sales by U.S. companies were $26.4 billion in the fiscal nine months of 2015, which represented an increase of 0.8% as compared to the prior year,” Johnson & Johnson (NYSE: JNJ ) reported. “Sales by international companies were $25.9 billion, a decline of 13.5%, including operational growth of 1.1%, offset by a negative currency impact of 14.6% as compared to the fiscal nine months sales of 2014.” 2 The Coca-Cola Company (NYSE: KO ) reported that over the most recent three months “fluctuations in foreign currency exchange rates decreased our consolidated net operating revenues by 8 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the South African rand, euro, U.K. pound sterling, Brazilian real, Mexican peso, Australian dollar and Japanese yen, which had an unfavorable impact on our Eurasia and Africa, Europe, Latin America, Asia Pacific and Bottling Investments operating segments.” 3 Determining Your Dollar Sensitivity WisdomTree believes currency sensitivity is an important factor that will continue to impact returns going forward, so to monitor the performance of this new factor, WisdomTree has created two new rules-based Indexes: The WisdomTree Strong Dollar U.S. Equity Index (WTUSSD) – This Index selects companies that generate more than 80% of their revenue from within the U.S. and then tilts its weight toward stocks whose returns have a higher correlation to the returns of the U.S. dollar. The WisdomTree Weak Dollar U.S. Equity Index (WTUSWD) – This Index selects companies that generate more than 40% of their revenue from outside the U.S. and then tilts its weight toward stocks whose returns have a lower correlation to the returns of the U.S. dollar. Since the inception of these Indexes, the U.S. dollar has strengthened 2.95% against a diversified basket of developed and emerging market currencies, leading to a performance advantage of 1.72% for WTUSSD compared to WTUSWD. 4 To try to understand what is behind this performance difference, we chart the median earnings and sales growth for the most recent quarter compared to the same reporting quarter one year ago, for both Indexes and the median for the entire universe. Year-over-Year Median Earnings and Sales Growth (click to enlarge) Strong Dollar Companies Displayed Higher Growth- The median earnings and sales growth for constituents of WTUSSD was more than 6% and 7% higher, respectively, compared to constituents of WTUSWD. We believe constituents of WTUSSD, or companies that generate more than 80% of their revenue domestically, tend to be less impacted by a strong-dollar environment-they aren’t focused on selling their goods and services abroad, and their import costs decrease with the rising purchasing power of the dollar. How Long Can This Persist? We have recently published a research paper, What a Rising U.S. Dollar Means for U.S. Equities White Paper , in which we illustrated the declining competitiveness of U.S. exports by graphing a ratio of exports of the U.S. economy over imports. As the U.S. dollar strengthened, the ratio of exports over imports weakened. Historically, we found that the impact can have a lag of around 36 months, so if history is any guide, we may not have seen the worst impact on exporters yet. At WisdomTree, our base case is still for a strengthening U.S. dollar, which may provide a continued headwind to U.S. multinationals with global revenue, but, depending on investors’ views, they can use the above Indexes to track the performance of either basket. Sources WisdomTree, Bloomberg. Johnson & Johnson quarterly earnings report, 10/30/15. Johnson & Johnson had a 1.21% weight in the WisdomTree Weak Dollar U.S. Equity Index as of 11/13/15. The Coca-Cola Company quarterly earnings report, 10/28/15. The Coca-Cola Company had a 0.71% weight in the WisdomTree Weak Dollar U.S. Equity Index as of 11/13/15. WisdomTree, Bloomberg, 5/29/15-11/13/15. U.S. dollar performance against a diversified basket of developed and emerging currencies is represented by the Bloomberg Dollar Total Return Index. Important Risks Related to this Article Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations. Tripp Zimmerman, Research Analyst Tripp Zimmerman began at WisdomTree as a Research Analyst in February 2013. He is involved in creating and communicating WisdomTree’s thoughts on the markets, as well as analyzing existing strategies and developing new approaches. Prior to joining WisdomTree, Tripp worked for TD Ameritrade as a fixed income specialist. Tripp also worked for Wells Fargo Advisors, TIAA-CREF and Evergreen Investments in various investment related roles. Tripp graduated from The University of North Carolina at Chapel Hill with a dual degree in Economics and Philosophy. Tripp is a holder of the Chartered Financial Analyst designation.

2 Screens To Avoid Bad Investments

Summary There’s no way to avoid all investments that end up performing poorly, but there are two screens that can avoid some of them: past price performance and hedging cost. We applied those two screens to a list of top investor picks three months ago, and the ones that passed both screens significantly outperformed the others. We elaborate on the two screens, and discuss why they work. We conclude with a suggestion to consider applying these screens to guru picks, and to consider diversifying or hedging to limit risk. A Bad Fall For Top Investor Picks In a late August article (“Best Q2 Picks From Top Investors”), Seeking Alpha premium contributor and hedge fund manager Chris DeMuth, Jr. highlighted what he felt were the best stocks top investing gurus such as Warren Buffett, Carl Icahn, and Seth Klarman (Klarman pictured below; image from DeMuth’s article) added or increased their weightings of in the second quarter. On the whole, these picks have performed poorly over the last three months. In hindsight, this is consistent with the narrowness of the current bull market, one dominated by the “FANGs”, Facebook (NASDAQ: FB ), Amazon (NASDAQ: AMZN ), Netflix (NASDAQ: NFLX ), and Google (NASDAQ: GOOG ), as John Authers noted in a recent Financial Times column. But what’s interesting is the divergence in performance between two groups of these stocks. The first group includes the guru picks that passed two screens to be included in a Portfolio Armor hedged portfolio, and the second group includes the guru picks that didn’t. One of those screens is simple enough you can run it without any specialized tools. We’ll detail both of the screens below, but first, here’s a look at how the two groups of guru picks have performed over the last three months. Guru Picks Portfolio Armor Included, 3-Month Returns: Advance Auto Parts (NYSE: AAP ), -14.43% Precision Castparts (NYSE: PCP ), +1.19% Cigna Corporation (NYSE: CI ), – 1.75% Danaher Corp (NYSE: DHR ), +10.83% Humana (NYSE: HUM ), -8.16% Perigo (NYSE: PRGO ), -16.2% Shire (NASDAQ: SHPG ), -8.5% Time Warner (NYSE: TWC ), -2% Average 3-month return: -4.88% Guru Picks Portfolio Armor Rejected, 3-Month Returns: SunEdison (NASDAQ: SEMI ), -32.06% SunEdison (NYSE: SUNE ), -71.15% Williams (NYSE: WMB ), -40.8% Baker Hughes (NYSE: BHI ), -6.83% Office Depot (NASDAQ: ODP ), -24.33% Altera (NASDAQ: ALTR ), +5.94% Icahn Enterprises (NASDAQ: IEP ), +0.54% Brookdale (NYSE: BKD ), -29.6% T-Mobile (NASDAQ: TMUS ), -6.47% Average 3-month return: -22.75% Screening Out The Worst-Performing Picks In an article published in early September (“Investing Alongside Buffett, Klarman, And Other Top Investors While Limiting Your Risk”), we entered each of the guru stock picks above into Portfolio Armor’s hedged portfolio construction tool. That tool works differently depending on whether you enter your own securities or not. If you don’t enter your own securities, the tool populates your portfolio with the securities with the highest potential returns, net of hedging costs, in its universe (its universe consists of every stock and exchange traded product with options traded on it in the U.S.). If you do enter securities, as we did with those guru picks, the tool performs two screens on the securities you enter before attempting to calculate potential returns for them. Screen #1: Most Recent 6-month Performance V. Long Term The first screen is one you can easily do yourself. The tool looks at how the ticker performed over the most recent six months and compares that to the average six month performance of the security over the long term (ten years, if a stock has been around that long; if not, it uses the long term returns of an industry competitor as a proxy; for exchange-traded products it uses since-inception returns if it hasn’t been around for ten years). The tool will reject any security with a negative return over the last six months, unless the average six month return of the security over the long term is greater than the absolute value of the most recent six months return. To illustrate this, let’s look at one of the guru picks that failed this screen, SunEdison . Below is a chart, via Yahoo, showing the performance of SUNE over the 6 months prior to when Portfolio Armor rejected it for inclusion in that September hedged portfolio: (click to enlarge) SUNE was down 48% over the six months prior to early September. The only way it would have made it past this screen is if its average 6-month performance over the last 10 years was greater than 48%, and, as you might guess, that wasn’t the case, so SUNE failed the first screen. Screen #2: Hedging Cost Since SUNE failed the first screen, it was eliminated. An example of a stock that passed the first screen, but failed the second, was Williams . WMB was down 3.25% over the most recent six month period as of early September, but its average 6 month performance over the previous 10 years was 4.81%, so it passed the first screen. But it was too expensive to hedge against a greater-than-9% decline over the next six months using an optimal static hedge, so it was rejected. We explained how to find optimal hedges in a previous article , if you’re willing to do the work manually, or you could use an automated tool such as our hedging app . Why These Two Screens Work Although these two screens don’t eliminate all poor-performers, they work to eliminate some of the worst performers. They both employ what New Yorker columnist James Surowiecki termed the wisdom of crowds : Large groups of people are “smarter” than an elite few, no matter how brilliant — better at solving problems, fostering innovation, coming to wise decisions, even predicting the future. The large group of people in screen #1 is the stock market, and the large group of people in screen #2 is the option market; the elite few are the top investors who picked the stocks. Conclusion If you’re going to buy gurus’ stock picks, consider buying ones that pass these two screens. And since these screens don’t eliminate all poor-performers, consider limiting your stock-specific risk by diversifying or hedging.

Market Strategies For 2015 And 2016

Market Strategies For 2015 And 2016 | Seeking Alpha Seeking Alpha ‘ + ”; $(‘header’).insert({ before: element }); _bindEvents(); Effect.BlindDown(‘ipad_beta_promo_container’, { duration: 0.5 }); } } function _bindEvents() { var closeBtn = document.querySelector(‘#ipad_beta_promo_container #close_promo_ipad’); if (closeBtn) { closeBtn.addEventListener(‘click’, function () { createCookie(‘hide_ipad_promo’, 1, 1); Effect.BlindUp(‘ipad_beta_promo_container’, {duration: 0.5}); Effect.BlindUp(‘keep_fixed’, {duration: 0.5}); Effect.BlindUp(‘close_promo_ipad’, {duration: 0.5}); }); } } add_ipad_promo_if_needed(); })(); 1. Market outlook for rest of the year; expectations for 2016; what were the main surprises in 2015? Expect a dive on 16th December, when the Fed announces its rate hike. The Bank of New York Mellon (NYSE: BK ) reckons that during Fed tightening cycles since 1946, every time the Fed has raised rates, the market has gained three per cent over the following 12 months after this “lift-off”. ( Financial Times , 10th December, 2015, p. 21). Then expect a year-end rally on account of portfolio managers wanting to improve their annual performance. Surprises: The market crash of September AND the way that the Chinese government tried to halt it with its interventionist policies. 2. Investment strategy; where to find opportunities; how to separate winners from losers How to separate winners from losers: use our Economic Clock®! Winners where there is an excess supply of money, or outlook of an excess supply of money. Losers: where there is an excess demand for money, or outlook of an excess demand for money. INVESTMENT STRATEGY The winners are Europe, Japan, the US and China: the first two have an excess supply of money; the US has a tiny excess supply of money and an improved earnings outlook (courtesy of an excess demand for goods). China will have an excess supply of money once the Central Bank loosens. This is not happening currently: indeed, when the Central Bank supports the RMB exchange rate, it buys RMB and sells dollars. But it then removes these RMB from circulation, so they are not part of money supply any more. SECTOR WINNERS are clearly soft commodities on account of a bad weather outlook. SECTOR LOSERS remain the industrial commodities: over-investment based on China euphoria are at the root of these losses. 3. Japan outlook; Abenomics and BOJ policy A winner – for all the wrong reasons. Her Economic Time® will continue being that of an excess supply of money and an excess supply of goods. Abenomics is dead in the water: that’s because the third arrow got bent by politicians unwilling to reform. Thus, like everywhere else, the Central Bank is left to pick up the pieces. 4. China markets; weak data signalling stimulus soon? Policy response is likely in the first quarter of next year . Indeed, the weaker RMB will help importers raise margins; but I remain doubtful whether the weak RMB can lift increasingly sophisticated exports. 5. Commodity rout; how long will it go? Oil prices See the Investment Strategy of question two above. Industrial commodities will continue suffering on account of a global excess supply of goods. Oil prices: Have nothing to do with our beloved demand/supply approach. Instead, they are all driven by politics of Saudi Arabia not wanting to accommodate Iran’s desire to produce 1 million barrels of oil/day. My guess is that everyone will scramble for market share, meaning that that excess supply of oil gets exacerbated. The good news is that this represents a massive tax cut for the consumer. 6. A Fed rate hike seems more likely this month. What’s your take? I guess “yes”; but this really depends on what the FOMC decides to focus on. If it is the US economy, then a rate hike is probable. But if it switches the floorboards again and decides to focus on China and on what the World Bank as well as the IMF are pronouncing, then all bets are off. I’ll believe that future rate hikes will take place gingerly, a bit like walking on egg shells.