The outlook for foreign stock ETFs (VPL)

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The rebound in the U.S. dollar, which commenced at the start of 2005 after the dollar had reached multi-decade lows, accelerated in May, writes J.D. Steinhilber, founder of ETF newsletter and investment management firm Agile Investing. The U.S. dollar index gained more than 4% last month, which dampened the dollar-denominated returns from international benchmarks and ETFs.

Political turmoil in Europe and associated disillusionment with the Euro have for the moment diverted attention from the major structural issue that continues to overhang the dollar, which is the $700 billion U.S. current account deficit.    

We took advantage of the currency-related softness in international ETFs in May to increase our international exposure in our Moderate and Aggressive portfolios at the same time we pared back our exposure to U.S. mid-cap stocks.  We opted to increase our international exposure in the Asia/Pacific region by adding a position in the Vanguard Pacific Stock Index VIPER (symbol: VPL), which tracks the MSCI Pacific Index.

This position further diversifies our portfolios into international equities, which we believe will offer superior returns to U.S. equities over the next several years, primarily due to their lower valuations. Every one of the stock markets in the MSCI Pacific Index (Japan, Australia, Hong Kong, Singapore, New Zealand) is trading at a valuation discount to the S&P 500.  Moreover, each of these economies is well positioned to capitalize on the most rapidly growing major economy in the world, which is China.

Although currency considerations were secondary in our decision to add this position, we think the recent dollar rebound is counter-trend and the next phase of dollar adjustment will be against the Asian currencies.  China is expected to begin to revalue its currency in the coming months, which could mark the beginning of this process.