recent world currency movements: stock market implications

dramatic changes

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.

the US

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.

Shaping a portfolio for 2012 (III): China


In assessing China, I think it’s important to distinguish carefully between the course of the mainland Chinese economy and the fortunes of China-related stocks.

the economy


The foremost goal of the Beijing government is to keep the ruling Communist Party in power.  This translates into the economic objective of avoiding possible social unrest by keeping employment high and unemployment low.  That’s quite a trick when you’re managing the transition from a rural, agriculture-based society to a more urban and manufacturing-oriented one.

In addition, China dedicated itself to creating a Western-style market-based economy in the late 1970s when it realized the country was too complex for central planning to work.  Again, hard to do when three-quarters of your industrial base was zombie-like state-owned corporations, when being a businessman was a felony and where citizens preferred to bury chuk kam gold trinkets in the back yard rather than use banks.

Complicating the situation further is the fact that high corporate or local/national government officials are Party officials whose chances for personal promotion are directly related to aggressively growing the areas they control, whether doing so makes long-term economic sense or not.


At the same time, all the mid-level national economic officials I’ve met–who actually implement policy–have been highly sophisticated, well-trained (mostly from the US or UK), competent and dedicated to creating healthy and balanced growth.

Given the large size of the Chinese economy and the paucity of tools to make economic policy, the best they’ve been able to do is to lurch between two extremes, overheating and stalling (the latter meaning unemployment is rising–a combination of new entrants to the labor force and layoffs)–and gradually lessen the amplitude of the cyclical swings.

where we are now

When the developed world appeared to be coming apart at the seams in 2008, China allowed a particularly strong domestic lurch to the upside.  For the past two years or so, Beijing has been trying to force an economic slowdown to rein in that expansionary impulse.

Policymakers have most recently been signalling their belief that slowdown has gone far enough and it’s time for faster expansion again.

China stocks

By and large, non-citizens can’t buy or sell stocks in the domestic market.  I’m not sure it makes much economic difference whether the local bourses go up or down.

Hong Kong is the natural market where the best and brightest of the mainland list their shares.

Over the past six months, Hong Kong stocks have sold off much more heavily than, say, the S&P 500, in response to worries about the Eurozone and potential global economic slowdown.  Since bottoming in early October, they’ve only rallied back in line with the S&P.  As I see it, so far there’s no anticipation of a better mainland economy this year in Hong Kong stock prices.  Many stocks there look cheap to me.

what to do

Personally, I think it’s important for all but the most risk-averse investors to have some exposure to the Chinese economy.

The most conservative way to do so is to hold companies listed in the US or Europe that have significant businesses in China.  Luxury goods retailers like LVMH, Tiffany or Coach are possibilities.  Casino companies like Wynn and Las Vegas Sands make all their money in Asia.

Discount brokers like Fidelity offer international trading services that allow foreigners to buy stocks in Hong Kong directly and cheaply.  Most investors will likely find it easier not to do research themselves, however, and buy an ETF or an actively managed mutual fund that specializes in Hong Kong or Greater China.

Price action in December and early January is often hard to read because of tax-related selling–losers in December, winners in early January.  Still, I’ve been a bit surprised that Hong Kong stocks haven’t done better than they have, given that the most recent economic news out of China, the EU and the US has virtually all been positive.

I don’t think this means that the positive case for the Chinese economy and for Hong Kong stocks is incorrect.  It may just take more time for negative emotion–from investors located in Europe, I think–to exhaust itself.  I’ve always thought that “buy on weakness” is pretty lame advice.  But it’s probably the right approach in this case.



Shaping a portfolio for 2012 (II): Europe

Europe–I’m not an expert…

I’ve been watching European stock markets for over 25 years, but I don’t consider myself an expert on Europe.  There are too many social and political quirks for me to get motivated to master its intricacies, given the relatively small size of each country, and of continental Europe in the aggregate, in stock market terms.  So I’ve taken an “American” approach and tried to just pick stocks.

…but everyone has to have a plan

On the other hand,  most stock market investors have to have a plan for dealing with Europe, since it’s a big trading partner with China and maybe a quarter of the revenues of the S&P 500 come from Europe.

Even a simple plan is almost infinitely better than nothing.  It gives you a baseline to monitor for signs that the reasoning behind your stock selection is wrong.  Rather than simply watch your stocks go down in flames, you can try to fix the budding problem.

Here’s my take on Europe:

There are a number of political groupings in Europe.  The widest is the EU itself.  Then there’s the Eurozone (all the countries which have adopted the common currency, the €) as a subset of the EU.  And there are other things like the Schengen free travel area.

For investors, the Eurozone is the most important of these.

To my mind, the defining characteristic of the Eurozone is that it has a common monetary policy, but fiscal policy that’s determined by each country.  This is what has the EZ in trouble today.

The ECB sets interest rates at a level that’s appropriate for the EZ as a whole.  For traditionally slower growing countries at the core, like France and Germany, that has arguably been too restrictive.  For faster growing, smaller economies on the periphery of the EZ, the rate has been extremely stimulative.

Easy money sloshing around the periphery found its way into massive numbers of speculative real estate deals.  Of course, each country should have recognized this and restrained speculation through cautious fiscal policy.  But what politician is going to take the punch bowl away from the party?  After all, there’s always an election around the corner.

To some degree, real estate speculation also infected the periphery with the “Dutch disease,” meaning that demand for construction workers drove up wages elsewhere–making other, export-oriented manufacturing industries less competitive.  For Americans, it’s like Detroit and the car industry.

If that weren’t bad enough, two countries, Greece and Italy, decided to game the system.

In my experience, Italy has always been the least economically responsible large country in Europe.  Yes, it took heroic measures to restructure itself to qualify to enter the EZ as a charter member.  But then it fell back into its old slovenly ways.

I’ll confess that I know next to nothing about Greece.  My impression is that it thinks membership in the EZ was a fabulous chance to scam the rest of Europe.  My impression is that it will happily default on its sovereign debt and leave the EU as soon as it gets a chance–sort of like skipping out on a restaurant check.  Luckily, its small size makes it a rounding error for Europe as a whole.

That’s the problem.  But where are we now?

I think we’re past the worst and on the way to fixing the current EZ problems.  I don’t mean the structural flaws in the EZ, but just today’s crisis.

We’re already seeing serious reform out of Ireland and Spain.  Greece and Portugal (another country where I have no clue) are too small to matter.   The real EZ economic uncertainty comes down to what happens in Italy.

Italy went through another painful wholesale economic reform process to enter the EZ and it has appointed economist Mario Monti as premier with a mandate for reform.  I think these are good signs that Italy is wiling to make the necessary changes to its economy once again.

One other point to mention:  a much simpler fix to problems in Italy and Greece would be to have the ECB loosen money policy by, for example, buying up Italian government bonds.  Doing so removes any incentive for Italy to reform, however–so it just kicks the can down the road.  More than that, money policy that’s inappropriately loose for Germany creates the need to use restrictive fiscal policy to offset it.  Angela Merkel certainly doesn’t want to have to do that.

my bottom line


Politicians in any area of the world only seem to me to act when the situation has deteriorated so far that the painful measures they need to implement are greeted with relief by the electorate as a “rescue” from a worse fate.

I think we’re at, or past, that point in the EZ and that the essential measures are already agreed to, through changes in government, that will end the current EZ crisis.

The main means of change will be austerity.  Once the ECB is convinced that Italy is sincere in its reform efforts it may provide some monetary assistance.  But cutting government spending and enforcing tax laws will be the order of the day.

For the European periphery, this spells recession today and low growth for a while after.

stock markets

The bigger question for equity investors is often not so much what the economic reality is likely to be as, rather, what economic scenario is currently being discounted in today’s stock prices.

I have four conclusions:

1.  I think today’s European stock prices discount a more pessimistic outcome than I see as probable.

2. I don’t think that attitude will change, however, until we see changes in EZ laws that are slated for March plus further concrete developments from Rome.

3.  I don’t want to bet the farm on my analysis.

4.  No matter what the precise outcome, Europe is likely to be the slowest growing area of the world in 2012.


I’m substantially underweight Europe.   I hold small positions in a couple of equity mutual funds, and one stock, through its ADR, IHG.  I would prefer Europe-listed companies that have most of their business in other parts of the world over primarily domestic-oriented firms.  I’d also prefer to reach into Europe through multi-nationals listed elsewhere that have some European exposure.

thinking out loud about Euroland (II)

Euroland is small

Yesterday, I tried to argue that in world economic terms the Eurozone is smaller than many investors believe and that, therefore, even a severe recession there next year will only have a mild negative impact on global growth prospects.

There are two additional economic factors to consider–trade and investor expectations.


Ex oil, most trade among Eurozone members is with each other.  Sales to the EU from China–Europe’s largest external trading partner–amount to less than 3% of the economy of either.  The same is true for business between the US and the EU.

Trade usually rises and falls faster than a country’s overall economy, though.  So a 5% decline in Eurozone GDP next year might translate into a 10% decline in imports.  Certainly not a good thing, but not by itself a disaster, either.

investor uncertainty

To my mind, the bigger issue by far is investor uncertainty.  Such fears typically turn out to be wildly overstated.  That knowledge doesn’t help much, however, if it’s your portfolio that’s being swamped by waves of irrational selling.

Even though Americans have been investing in foreign stock markets in a serious way for almost thirty years, I think most people still don’t understand that there isn’t a one-to-one relationship between world economies and world stock markets.  The relationship works for bonds, which comprise a much larger class of securities, but not for equities.

There are two reasons for this:

–in most countries, large portions of the economy have no publicly listed companies.  In the US, for example, the real estate, housing and auto sectors, all of which are important for GDP growth, have very little stock market representation

–in many countries, the owner of a domestic enterprise can easily be a foreign company.   In this case, the owner’s main public listing is probably in a foreign country–if it is listed at all.  Again, it contributes to GDP but has no local stock market presence.   TIF, for instance, is a US company but earns money and adds to GDP in the EU, Japan and China.  Ikea is a global furniture company founded by a Swedish entrepreneur.  It’s incorporated in the Netherlands and not publicly traded anywhere.

world stock markets by size

In world stock market terms, the Eurozone is smaller than it is in a macroeconomic sense.

The world stock markets open to foreigners break out roughly as follows:

US          45%

Eurozone          11%

rest of Europe (mostly the UK, with a dash of Switzerland and Sweden)          13%

Japan          9%

Canada + Australia          8%

emerging markets          14%.

Slicing the Eurozone up a bit further, the area’s main components are Germany and France, which together make up more than half the total.   By far the biggest sector is financials.

Unfortunately, there’s no reliable information I’m aware of to sort out the relationship between where companies in continental Europe may be listed vs. the countries where they make their money.  I think we should assume that all financials are pan-European enterprises, no matter where they are listed.  For other sectors, the tendency has been for countries to declare that certain companies or industries are national treasures and can’t be acquired by foreigners.  My guess–and it really is a guess–is that ex financials, most multinational exposure is to non-Eurozone areas.  If so, this exposure would be an economic and stock market plus.


In the parsing of world stock market above, which gets down to the level of markets that make up as little as 2% of the world’s stock markets, Greece, Italy, Portugal and Spain don’t show up at all. They’re that small.

In terms of investor concern that’s depressing overall European markets, then, the issue has got to be either the indirect effects on business in France and Germany of problems in smaller Eurozone economies and/or the negative effects on the very large banking sector.  My guess is that the negative signal European markets are giving is much more the latter than the former.


Tomorrow–how to structure an equity portfolio in light of European stock market weakness.

thinking out loud about Euroland (I)

recent trading

During this latest iteration of the Eurozone existential crisis, we’ve dropped from 1350 on the S&P 500.  We’ve visited 1074 and seen 1284, both within weeks of one another.  We now seem to be generally moving sideways, but bouncing between 1215 and 1270.

What is the market saying?  This trading pattern says to me that the market is highly emotional but no one has a clue to figuring out what’s going on in the Eurozone.

thoughts on Euroland

As a first step toward developing a (hopefully) intelligent stance to take toward the Eurozone in building an equity portfolio, I thought I’d try to list the points I feel confident about.  That may be enough for me to use;  at the very least, I may be able to highlight what other information I really need to know.

Here goes:

1.  Matters would be worse on Wall Street if the US economy weren’t recovering.  While not thrillingly optimistic, the view of Jim Paulsen, Wells Fargo’s chief investment strategist, is an interesting–and, to me, a completely plausible one.  He terms the current sluggish recovery as normal for the US in today’s world.  It only looks bad when we compare it with recoveries from thirty or forty years ago, when economic circumstances were very different.

2.  The Eurozone won’t be generating much economic strength for years, I think.  If so, as investors we should regard Europe as a special situations market and be very choosy about what stock we own.  If we take it as given that we don’t want much exposure, our biggest concern has to be that the economy there gets bad enough that it punches a hole in the bottom of the world’s economic boat.

Why do I think European prospects are dim?

–Japan hid the banking problems that resulted from its late-1908s speculative bubble for a decade.  Its economy stagnated during that time.

–The US fixed the worst damage to its banks almost immediately and the economy began to perk up 18 months later.

–Euroland?  So far, it has followed the Japanese example.  The result has been little growth and creation of the only negotiating chip places like Greece and Italy have.  Even if the EU recapitalized its banks tomorrow, we wouldn’t see the positive economic effects until 2013, at the earliest.

3.  Euroland’s investment importance comes from the accumulated wealth its citizens hold, not its size or growth prospects. 

How so?

Look at the Eurozone’s (small) size.

Using Purchasing Power Parity calculations from the World Bank (I got them on Wikipedia), global economies break out as follows:

Brazil, Russia, India, China         25% of the world

US, Canada, Mexico          23%

Eurozone          15%

rest of EU          5%

Japan          6%

everybody else          26%.

I draw two conclusions from this list:

–Euroland isn’t that big in world terms any more.  The fate of the “other” 85% is hugely more important than what happens in Europe.

–One possible outcome for the Eurozone is that it fades into insignificance in the way that Japan has during the past two decades.  I’m not sure this is the most likely outcome, but it’s a good possibility.  After all, the EU has many of the same cultural rigidities that have helped to sink Japan, and it hasn’t fixed its banking system.  Japan’s economic collapse didn’t stop the 1990s from being a very profitable decade for investors elsewhere.

4.  The worry isn’t a deep recession in Europe–it’s uncertainty about unanticipated consequences.  At least, I don’t think it should be about Eurozone recession.  According to the Conference Board, a US-based economic consultant, the world is likely to grow by about 3% in real terms (that is, after subtracting inflation) in 2012.  The agency thinks  the EU is most likely to grow by 1%;  its “pessimistic” scenario has the area little better than flat for the next half-decade.

What does Europe mean for overall world economic expansion, in the Conference Board’s view?  Realistically, nothing.  In the base scenario, the EU chips in .15% to world growth–more or less a rounding error.

Let’s assume that somehow the bottom falls out of Europe next year and the Eurozone has a horrible recession where output shrinks by 5% in real terms.  That would subtract .75% from world expansion.  The globe would still grow, but by 2%+ instead of 3%.


That’s it for today.  More on this topic tomorrow.

investing in stocks outside your own country: the Vale example

Still at spring training. So far, the Mets have beaten the Braves (five Atlanta errors) and lost to the Cardinals.

Investing in a foreign country

In my experience, one of the most difficult (and expensive) things to learn about investing outside your home country is that what you consider to be self-evidently and commonsensically true about the characteristics of good investments there isn’t necessarily so in someone else’s market. Instead, the rules that govern each market are the product of that nation’s legal framework, its shared social norms and the risk preferences of the dominant investors there (be they local or foreign), as well as the objective characteristics of the companies that are publicly listed.

The situation is made more difficult because we’re all, at least initially, not consciously aware of our deepest presuppositions about our own market. We don’t think to ask anyone in a new market what the rules of the game are, either, because we assume they’re the same as ours. And the people in the new market that we might ask are, like ourselves, probably not consciously aware of the assumptions they share with their fellow local investors.

Take the US and UK markets, for example. Superficially, the two are very similar. They have the same general language, same general legal system, same general accounting conventions. One is the former colony of the other. They are political allies. Everyone talks about Anglo-American capitalism as being different from the Japanese or continental European varieties.

Yet the two markets are quite different.

For example:

–Americans “know” that debt is a cheaper form of capital than equity; British investors “know” the reverse.

–The letter of the law is paramount in the US. In the UK the spirit of the law is more important. If some one can figure out a way to exploit imprecise wording in a contract to achieve an advantage, he’s likely lionized in the US. In the UK, he’s vilified.

–UK investors prefer to own the stocks of mature companies that generate free cash flow, pay rising dividends and have low price-earnings multiples. US investors are pretty evenly split between such value investors and growth advocates, who prefer younger, faster-growing firms that are cash flow users, not generators, and pay no dividends. US individual investors are prepared to pay very high PEs for stocks in the latter class.

How does one learn these rules? Mostly through experience—and through being aware that it’s important to be on the lookout for them speeds up the process immensely.

At the present time, there’s an interesting instance of “local ground rules” in progress, one that will go a long way toward fleshing out the rules of investing in Brazil, a potentially important emerging market. Here it is:

Vale, a large, publicly listed company in Brazil, is one of the world’s most important miners and exporters of iron ore. Iron ore is the main raw material used to create blast-furnace steel, the type of steel used to make automobiles. Vale’s most important customer is the steel industry in China.

Although Vale is happy to remain a miner/exporter, the current Brazilian government isn’t content with the current state of affairs. According to a recent Financial Times article, it wants Vale to integrate forward by investing in steel mills in Brazil and so it can produce steel for export in its home country. Vale is refusing.

The government’s response? …to force the current Vale CEO out of office, in the hope of replacing him with someone willing to adhere to the government’s wishes. As I see it, the government’s reasoning for its action is not that becoming a producer of steel, in direct competition with its largest iron ore customer, will be good for Vale or its shareholders. The rationale is that it will be good for Brazil.

It isn’t clear yet whether the government will get its wish.  I suspect that if I knew more (read: anything) about the Brazilian legal system, I’d have found tha there’s a deep-seated belief that natural resources really belong to the citizenry as a whole, that private companies don’t own natural resource deposits in the same way they do other assets.  And that idea is the basis for the government’s request.  If so, this might imply other industries might be immune from these tactics.

But every country has investment issues like this.  In Korea, for example, if a company is seen to be making “too much” money, it has been asked to make a “voluntary” contribution to some government-sponsored research project.  In Japan, the banks were never intended to make money; they were intended to gather national savings to make cheap loans to export-oriented companies.  Recently, we’ve learned that yoghurt-production is a key b in France, and thus not subject to foreign takeover.  For a decade or so, US oil companies were legally barred from charging market prices for the oil they brought to the surface.  And the US has massively protected/subsidized the domestic auto industry for as long as I’ve been a professional investor.

My private belief is that these quirks end up being bad for the capital markets anyplace they’re enforced.  They result in inefficient allocation of capital.  And that results in lowe price earnings multiples for stocks in the affected industries.

In a practical sense, however, there’s nothing any single investor can do about the local house rules  …other than to be aware they exist, lurking under the surface, everywhere–and take appropriate protective measures.