A recent Wall Street Journal> article by E.S. Browning pointed out the increasing correlation among U.S. stocks, which now show the highest tendency to move in the same direction as a group since October 1987. Historically, that correlation has been 0.44. By last week, it hit 0.83, indicating that there s not much differentiation between risks. When equities fall, they all fall.
One idea is to complement a portfolio with a risk beyond simply equities. Adding currency exposure to a stock portfolio isn t nearly as exotic as it once was but can still accomplish the goal of diversifying one s holdings beyond equities.
It wasn t too long ago when the attraction of foreign currency investing was the carry trade, borrowing in low-yielding currencies like the Japanese yen in order to invest in higher-yielding options like the Russian Ruble or Brazilian real. But in the current environment of ultra-low interest rates the world over, investment return is now a function of the price action more than than yield.
New Zealand Dollar & South African Rand Rolling Three-Month Correlation Against S&P 500
Source: Rosewood Research>
Two risk currencies have quietly separated themselves as strong assets not correlated to the major stock indexes, and deserve of further consideration.
A Worthwhile New Addition
WisdomTree Dreyfus New Zealand Dollar Fund (BNZ) 1 year>
The New Zealand Dollar, tradable via any stock account via shares of WisdomTree Dreyfus New Zealand Dollar Fund, is poised to retest its 2010 high, flat for the year but outpacing U.S. equities with significantly less volatility. The kiwi boasts a negative 0.67 correlation (rolling three-month) to the S&P 500, meaning that it tends to move independently of U.S. stocks.
The fund could benefit from a gradual rise in interest rates as set by the Reserve Bank of New Zealand, as many economists anticipate. One trend-following strategy would entail taking an initial position in the ETF around current prices of $23, using a stop-loss order near the multimonth low of $21. A return to levels seen last fall would put the fund near $26.
Favor the Currency, Not the Cup
WisdomTree Dreyfus South African Rand (SZR) vs. S&P 500 3 month>
Another commodity currency that s held up surprisingly well is the South African rand, first profiled in this space back in 2008 and tradable long or short via WisdomTree Dreyfus South African Rand.
Decimated as investors fled risk during the financial collapse, the Rand has since returned to pre-crisis levels and has channeled within a 10% range for the better part of a year. An increased appetite for risk and continued inflows into emerging markets could quickly prompt a breakout; strength-following traders might consider a position in SZR near $29 with stops below at $26.
From a portfolio perspective, the biggest attraction is the asset s -0.78 correlation to the S&P 500 (rolling 3-month), meaning that in the current environment the Rand provides even more diversification to a stock portfolio than gold, which more closely tracks the stock market with a correlation of -0.24.