Is your investment portfolio protected from a falling euro? Ignoring exchange rates can have a negative effect on your investment returns. Correctly anticipating currency fluctuations by adjusting your assets can protect and even increase the value of your portfolio. In this article I will outline why I believe the euro will depreciate against the U.S. dollar in the next 12 months, how it may affect your portfolio, and what you can do to protect your investments and even profit from a weakening euro.
Why I believe the euro will depreciate
The largest reason I believe the euro will depreciate against the dollar is simple: The European Central Bank wants this to happen. One ECB governing counsel member recently expressed that the bank is considering the use of negative interest rates to fight the appreciation of the euro. He also mentioned the possibility that the bank will add liquidity to the market (which is a fancy way of saying the ECB might start buying U.S. dollars with euros to suppress the exchange rate of the euro relative to the dollar).
The ECB's comments combined with the new Federal Reserve Chair, Janet Yellen's recent comment that the U.S. Federal Reserve may raise rates as soon as soon as next Spring and will continue the wind down of its bond-buying cuts points to a lower euro relative to the U.S. dollar.
The bottom line of these comments appears to be, the ECB doesn't want a stronger euro and the U.S. Federal Reserve doesn't want a weaker dollar. A tried and true rule of trading on Wall Street is "don't fight the Fed!" (this saying could also apply to the ECB).
In a nutshell, listen to what the central banks are telling investors; they often give us clues on where they want exchange rates to go. It is your job to adjust your portfolio accordingly.
How a depreciating euro may affect your portfolio
If you own stocks of companies who do business in Europe, your portfolio has some exposure to the euro: the companies you own likely receive euros as payment for products or services in Europe and converts the euros back to its domestic currency. A depreciating euro will negatively affect the value of the company's converted currency. In a nutshell, a depreciating euro could mean lowered profits for the euro-exposed companies you own shares of.
What you can do to protect your investments from a depreciating euro
To offset the negative affects of a depreciating euro on your portfolio, an investor has many choices. You can directly short-sell the euro/U.S. dollar pair, enter a forward contract to purchase euros by selling U.S. dollars at a future date, purchase a currency put option -- the list goes on. However, these types of dealings can be complicated, and most require special brokerage accounts. If you're not a seasoned financial professional, you may prefer the simpler route: exchange traded fund investing. Two great ETFs you can use to protect your portfolio from a weakening euro are the ProShares UltraShort Euro (NYSEMKT: EUO) or Guggenheim CurrencyShares Euro Trust (NYSEARCA: FXE).
Description of EUO:
This fund reacts to fluctuations in the euro by inversely increasing or decreasing twice as much as the euro relative to the U.S. dollar. For example, if the euro depreciates by 1% against the dollar over the course of one week, EUO will increase by 2% in that same week. If the reverse happens and the euro appreciates against the U.S. dollar by 1% over the course of a week, EUO will decrease in value by 2% in that same week.
Description of FXE:
This is a grantor trust. Meaning the trust issues shares in exchange for deposits of euros. The investment objective of the fund is to mimic the price of the euro plus accrued interest. Since the interest rates of the euro and U.S. dollar currently identical at .25%, the fund moves in lockstep with the euro.
How to use these funds:
If you believe the euro will depreciate against the U.S. dollar and you own stocks with euro-exposure or you're simply trying to make a profit from the currency movement, purchasing some shares of EUO or short-selling shares of FXE may help you offset the negative effects of a depreciating euro, and/or serve as a way to create capital gains for your account.
Of course, like any investment, there are risks: if you purchase shares of EUO or short-sell shares of FXE and the euro appreciates relative to the dollar, this will create capital losses on your account. Also, currency speculation is one of the most difficult investment endeavors. Unlike the U.S. stock market which has trended upward over the long-run, the currency markets have had no definite pattern to follow. So, unless you are very confident that the euro will depreciate against the dollar, this fund may not be right for you.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.