System Signals This International ETF Is the Best 'Buy' in the World Markets

By Michael J. Carr on May 2, 2013

Economies around the world seem to be stuck in slow growth. While this may sound bad, stock markets have been unconcerned about the slow pace of growth, and prices have continued to move higher in almost every market around the world.
Unfortunately, it's possible to be in the right market but see subpar returns. International investing is a great example. If traders find the right market, but trade it in the wrong currency, they'll only see a percentage of the return.
Japanese stocks offer an example of how currency changes can impact stock market returns.
The Nikkei 225, a benchmark index for Japanese stocks, is up 29.1% since the beginning of the year. U.S. investors could gain exposure to Japanese stocks with iShares MSCI Japan Index (NYSE: EWJ), but that ETF is only up 17.4%.

This is a common situation for international investors. U.S.-based international ETFs see returns that differ significantly from an index that tracks the foreign market in a local currency. One reason for this difference in returns is a change in the value of the currency.
As the Japanese central bank pursues an aggressive quantitative easing strategy, the yen is becoming weaker. It is falling relative to the U.S. dollar, and that decline is hurting U.S. investors' returns.

Using round numbers, we can illustrate the problem U.S. investors face. At the end of December, a dollar would have bought about 85 yen. Let's assume you bought 8,500 yen worth of Japanese stocks with $100. The stocks are now up 30% and are worth 11,050 yen.

You decide to sell for that amount and convert your yen back to dollars. The exchange rate is now 98 yen per dollar. That means 11,050 yen will be worth about $113. You made a profit (13%), but after the impact of the currency movements, you made much less than a Japanese-based investor (30%).
Some funds will use strategies to neutralize the currency risks. This can be done using futures contracts or other derivatives and adds a small expense for the fund. At times when currencies are making large moves like they are now, that extra expense is not a concern.
WisdomTree Japan Hedged Equity (NYSE: DXJ) is an ETF that hedges the currency exposure while investing in Japanese stocks. The fund is up 25.6% since the beginning of the year, much closer to the 29.1% return of the Nikkei.

Based on my 26-week rate of change (ROC) system, DXJ is a "buy" this week. This system is designed to own the strongest ETFs, buying after the ETF has outperformed the broad market over the past six months. Many studies have shown that the strongest performers of the past six months are likely to be among the biggest winners in the future.
Currently, the system is holding iShares MSCI Ireland (NYSE: EIRL) in the portfolio. EIRL was added to the portfolio at the end of January and has gained 6.8% since then. Over that same time frame, SPDR S&P 500 (NYSE: SPY) has gained 7.1%.
The chart for EIRL actually looks good, but based on the 26-week ROC, DXJ has been a stronger performer. Since I only hold the strongest ETF in an asset class, the system is selling EIRL and adding DXJ.
Recommended Trade Setup:
-- Sell EIRL at the market price
-- Buy DXJ at the market price
After completing the two trades, the portfolio will consist of only two positions. My system shows that the other three asset classes have a high level of risk right now, and it is best to avoid markets when the risks exceed the potential rewards.
Source: www.profitabletrading.com