Although currency movements sometimes can often be overlooked by a stock market investor immersed in the hustle and bustle of day-to-day trading action, there have been a couple of whopping big moves in major currencies over the past half-year.
Since late July 2012, the euro has risen by 12.5% against the dollar. Over the same time span, the yen has fallen by about 16.5% against the greenback. A quick bit of multiplication tells us this also means that the euro has risen by about 30% against the Japanese currency.
To my mind, there’s no really satisfactory general economic theory about how currencies work. But to give a sense of perspective, inflation in Japan has been, say, -1% on an annual basis over the second half of 2012. We’ve had +1.5% in the US. Euroland has experienced a 2.5% rise in the price level. Inflation differentials imply that the yen should be rising against the dollar at a 2.5% annual rate and against the euro by 3.5%. The euro, in turn, should have weakened by 1% against the dollar and 3.5% against the yen. The actual outcome has been far different.
Of course, there are reasons for the spectacular assent of the euro and the plunge of the yen. Until around mid-year, many observers thought Euroland was coming apart at the seams and rushed to get their money out before the demise. I’m sure there was more than a touch of flight capital mixed in the outflows. Thanks to Mario Monti’s and Angela Merkel’s actions indicating the political will to save the euro, capital flows have reversed in spectacular fashion.
Newly-elected Japanese Prime Minister Shinzo Abe made it a central plank of his campaign for office that he intends to force the Bank of Japan to print lots of money. Why? …to weaken the yen and to create inflation. The move could easily end in eventual economic disaster, but for now its main effect has been to drive the Japanese currency down a lot versus its trading partners’.
stock market implications
Generally speaking, a rising currency acts to slow down the domestic economy. A falling currency gives the economy a temporary boost.
Currency changes can also rearrange the relative growth rates of different sectors. The best-positioned companies will be those that have their sales in the strongest currencies and their costs (e.g., labor, raw materials, manufacturing) in the weakest.
The decline of the yen has given Japanese export-oriented firms a gigantic relative cost advantage against European competitors, and a significant, though smaller, one against US rivals–or those located in any country that ties its currency to the US$. Anyone who sells products in Japan that are imported, or made with imported raw materials, has been crushed.
We’ve seen this movie before, however, on a couple of occasions. It’s ugly. Domestic firms lose. Exporters will make substantial profit gains in the local currency. But from a stock market view, that plus–with the possible exception of the autos–will be offset for foreigners by currency losses they have/will endure on their holdings. Stocks in even the most advantaged sectors will deliver little better than breakeven to a $ investor, and will certainly rack up large losses to anyone interested in € returns, in my view.
The EU has already had a return-from-the-dead rally, where stocks of all stripes in the economically challenged areas of southern Europe have done well. The message of the stronger currency is that importers, or purely domestic firms in defensive industries will fare the best from here. Although I think the preferred place to be from a long-term perspective is owning high quality export-oriented industrials, the rise of the euro has blunted their near-term attractiveness. One exception: multinationals based in the UK, because sterling hasn’t participated in the euro’s rocketship ride.
Ideally, you’d want a firm that imports Japanese goods into the EU.
Americans are less accustomed to thinking about currency effects that investors in other areas, where their effects are more pervasive. With the dollar being in the middle between an appreciating euro and a depreciating yen, currency effects will be two-sided. Firms with large Japanese businesses, like luxury goods companies, will be losers. Firms with large European assets and profits, like many staples companies, will be winners. Tourism from the EU will be up, from Japan, down. One odd effect, which I don’t see any obvious American publicly listed beneficiary–the decline in the yen is causing the cost of living for ordinary Japanese to rise sharply, since that country imports so many dollar-price raw materials. To offset that effect, Japan is beginning to weaken protective barriers that have kept much cheaper finished goods (like food) from entering the Japanese market. Doubly bad for Japanese farmers, though.