Tag Archives: currency

dealing with a rising currency

March 12, 2015 By in economics, growth vs value, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , Leave a comment

As far as the stock market is concerned, there are two main strategies for dealing with a rising currency:

1.  try to make currency work to your advantage

Profit growth will be highest for a company in a changing currency environment if it has its costs in weak currencies and its revenues in strong ones. In today’s world, this means having costs in, say, yen or euros and sales in the US.

The “good” stocks in weak currency countries gain in two ways:   from stronger profit gains and from domestic portfolio managers rotating their holdings toward the “good” industries.

The obvious candidates are export-oriented firms with high labor content in weak currency countries.  In these areas, firms with high strong-currency import content that sell finished products into the domestic market are the worst ones to hold.

 

In strong currency countries, in contrast, purely domestic stocks are the best bet.  They benefit only from portfolio manager rotation, though.  But they avoid currency induced weakness.

 

2. ignore currency and look for secular growth names whose expansion prospects outweigh possible currency losses 

As a growth investor, this is my preferred strategy.  Historically, the majority of such stocks have been in the US.  In today’s world, however, the ideal investment would be in a hot EU tech company with exposure to the US.

Any ideas?

December 2014 earnings for Microsoft (MSFT)

January 27, 2015 By in earnings conference calls, Stock ideas Tags: , , , , , , 3 Comments

the report

Last night MSFT announced earnings for the December 2014 quarter, which is the second fiscal quarter of 2015 (ends in June).  At eps of $.71 a share, results were in line with analysts’ expectations, even though income was dinged by $.02  by restructuring charges and $.04 from an IRS audit adjustment.

Overall, the report was a mixed bag.

On the one hand, the restoration of MSFT to relevance under new CEO Satya Nadella continues apace.  On the other, the renewed vigor that the traditional MSFT business has been exhibiting recently appears to be coming to an end.  In particular,

–In the earnings release on the MSFT website (data are humorously difficult to download if you don’t own Office) the company made it clear that the period of extra oomph to sales of Windows caused by the termination of XP support has come to an end.  Sales had been boosted both by some former XP users upgrading to new machines and by others simply buying a newer OS.

–It’s also clear that we’re entering a period where currency effects–the decline of the euro and the yen vs. the dollar–are going to have a significant negative impact on earnings.  I think this means a drop of somewhere between 5% and 10% vs. where profits would be without currency movements.  This loss takes two forms:  a decline in the value of foreign currency-denominated assets, which is recognized immediately (in 2Q15 the figure was ($390 million); and the lower dollar value of foreign currency-denominated sales.  Part of the latter is recognized in income immediately but most sits on the balance sheet as deferred revenue before reaching the income statement (this is a long-winded way of saying that some currency losses won’t be booked for a while).  And, of course, the euro is about 8% lower today than it was on December 31st.  MSFT estimates the 3Q15 loss at 4% of revenue.

The net result of these two negatives will likely be that eps for MSFT will be flattish over the coming twelve months, rather than the +10% that most analysts appear to have been forecasting.  (How they justified these numbers in the face of the strong dollar is another issue.)

the stock

As I’m writing this, MSFT shares are down by 10%, in a market that is off by a bit less than 2%.

It’s also a day on which I’m sure lots of people didn’t make into work (and those who did are in a bad mood), as well as one where a raft of negative-surprise earnings releases have been issued.  So it’s not a good day to announce bad news.

Still, I’m personally a bit surprised by the extent of the negative reaction.  I’m not sure quite qhat to make of it, other than it’s very negative.

I have no desire to sell the MSFT I own.  On the other hand, I have no burning desire to buy more.

If I thought 2015 would be a sharply up year for stocks, I’d probably be thinking of selling to buy something with more upside potential.  But I expect the market to basically move sideways this year.  So I’ve got to be more concerned that this decline is just the first stop on a down elevator.  Right now, I don’t think that’s right, either.  But that’s where analysis has to be focused.

My biggest reaction is that I’ve got to look even more carefully through the stocks I own to uncover exposure to weak foreign currencies.  Ultimately, I guess, I believe this is the cause of the sharp MSFT price drop.

The main thing the MSFT report tells me is that Wall Street is much less far along than I would have imagined in discounting currency losses to US-based multinationals from a declining euro.  A second observation is that the European stock markets have probably been as poor at factoring in earnings gains that euro-based firms are achieving from their dollar exposure.

 

 

 

 

the euro, the US$ and the Swiss franc

January 23, 2015 By in currency effects, currency markets, Current Market Thoughts, securities markets Tags: , , , , , , , 6 Comments

With the beginning of quantitative easing by the European Central Bank, the euro has slipped against the USD by about another 3% today to a value of 1 € = US$1.12.  That’s a decline in the euro of about 7.5% just since January 1st.  The EU currency has tumbled by more than 14% vs. the greenback over the past year, and by almost 20% since its high of $1.39+ last May.

This is an astounding fall for the world’s second most important currency.  It’s an enormous boost for EU-based enterprise overall and for exporters in particular–as well as a huge burden for their hard currency-based rivals. It would also be a mind-boggling loss of national wealth for EU citizens, were it not that Japan has depreciated the yen by a third over the past few years in a bid to regain global relevance for its manufacturing base.

Enough of this.   Down to brass tacks:

the euro/dollar

The income statements of US companies with EU exposure will be savaged by the currency decline.  Yes, in theory they may be able to raise prices to recover some of their depreciation-created losses.  But the general rule in this situation is that prices can only go up in line with overall inflation–which is non-existent in the EU at the moment.

My strong feeling is that Wall Street hasn’t fully worked this out yet.  So combing through our holdings to find euro victims should be a high priority for each of us.

the euro/Swiss franc (CHF)

The CHF has gained almost 25% against the euro since the Swiss central bank depegged its currency from the euro a little more than a week ago.  The speed of the move clearly shows what should have been apparent over the past year of euro depreciation–that the Swiss government was trying to maintain a peg that was miles away from where the cross rate would be without constant economy-distorting intervention.

We know this sort of thing can’t last.  If the forty-year history of floating exchange rates shows anything it’s that trying to maintain an artificial exchange rate always ends in disaster.  Yet what continues to come out in the press post-depegging is that:

–lots of EU property owners had decided it was a great idea to take out a CHF-denominated mortgage on their homes.  Short-term rates were negative, after all.  Ouch!

–a number of commodities brokers are in serious financial trouble because they allowed individual clients to build up short-CHF positions on margin that were so big there’s no chance they’ll ever be able to repay the losses they’ve incurred.

–there’s been a parade of currency trader departures from hedge funds caught out by the same short-CHF bet.

I guess this just shows that P T Barnum was right–that despite the examples of the collapse of the pre-euro Exchange Rate Mechanism in the early 1990s, the Asian debt crisis later in that decade and all of the problems with one-size-fits-all Eurobonds, there are still tons of people willing to take what history shows is the losing side of a wager.

 

 

what just happened to the Swiss franc (CHF)

January 15, 2015 By in Recent Market Action, Switzerland and the euro Tags: , , , , , 5 Comments

background

Pre-financial crisis one euro bought close to 1.7 chf.

As progressive waves of bad news about the EU financial system broke–that, for example, its banks were stuffed to the gills with worthless US mortgage derivatives, or that Greece had faked its national financial statements for years and was unable to pay its (euro-denominated) national debt–EU investors began to sell their currency and buy the chf, whose value began to rise.

In mid-2011 a sudden spike upward in demand brought the Swiss currency to the point that a euro bought less than a single chf.

the cap

That forced the Swiss National Bank to step in to stabilize its currency, fearing that continuing gains in the chf would have terrible negative effects on tourism and on exporters.  The SNB set a cap on the value of the chf at 1.2 per euro.  The chf could trade cheaper than 1.2 per euro, but the central bank would always be there to buy euros at the 1.2 rate if needed to prevent the chf from appreciating further.

problems

This action fixed the immediate problem of appreciation of the dhf against a key trading partner.  But it did two bad things at the same time:

–it effectively tied the currency to a now-nosediving euro, and

–it expanded the Swiss money supply in a potentially unhealthy way.

today

This morning the SCB made the surprise announcement that it was going to let the chf float against the euro again, effective immediately.  The currency spiked to 1.0 euro before settling in at around 1.1 euro.

Why the surprise?  

I can think of several reasons:  the Swiss government didn’t want to buy any more euros.  I imagine it anticipated it would be swamped with buy orders for the chf during any phase-out period.  Currency traders may have anticipated this move and been buying boatloads of euros from the Swiss government in recent days, effectively forcing the SCB action.

Why do this at all? 

That’s the interesting part.

Switzerland apparently anticipates that when the ECB embarks on quantitative easing, the result will be some pretty ugly currency action for the euro.

 

the shrinking euro (and yen)

January 5, 2015 By in currency effects, EU financial crisis, Strategy Tags: , , , , , , , , , Leave a comment

the shrinking euro

This time a year ago, it cost $1.36 to buy a euro.  It was $1.39 by March.   The euro then moved sideways vs. the greenback until early summer–when it began an almost continual descent that has the EU currency now trading at just above $1.19.  That figure is down 14% from the 2014 high, and off 12.5% from the year-ago level.

reasons?  

The surprising revelation last summer that the overall EU economy was slowing, not accelerating as most observers, myself included, had expected is the most important, I think.  Sanctions against Russia and recent worries that a new Greek government might repudiate its sovereign debt have just added to the funk.

The Japanese yen has tracked more or less the same course vs. the dollar as the euro–meaning that neither Japan nor the EU has gained/lost competitiveness vs. its main global manufacturing rival.

Looking at the situation from a more conceptual level, both Japan and the EU have relatively old populations and both give much higher priority to preserving their traditional social order than to achieving economic progress.  Neither characteristic argues for long-term economic/currency strength.

consequences

economic

In the short run, currency declines stimulate overall economic activity.  They also rearrange growth to favor exporters, import-competing industries and service industries like tourism.  This means that local currency profits for firms that have their costs in euros and revenues in harder currencies will likely be higher than generally anticipated.

The huge fall in oil prices will still be stimulative, but the edge will be taken off the benefit a bit by the currency decline.

Euro-oriented holders of dollar-denominated assets benefit; dollar-oriented holders of euro assets are hurt.

financial markets

I expect European bond managers will continue to boost their holdings of US Treasuries, figuring they’ll get both yield pickup and an anticipated currency gain.  This flow will keep long-term interest rates in the US a bit lower than they would be otherwise.

Equity managers will shift European holdings more toward multinational firms with dollar-denominated assets and earnings.  Some of this has happened already.  Many times, though, PMs will wait until they see the weak currency stabilize before reallocating.  Personally, I don’t think waiting makes any sense, but that’s what people seem to do.

US firms with European assets and earnings will face the double negative of slow growth in the EU and the diminished value of EU profits in dollars.   I think US-based manufacturers of consumer staples are particularly at risk.

hedging

While the extent of the decline of the euro may be a surprise, the fact that it’s a weak currency shouldn’t be.  This means many US companies that have euro exposure will have hedged away part of this risk.

I have conflicting thoughts on this issue.  Almost universally, investors ignore profits gained by hedging.  The idea, which I agree with, is that in short order the favorable hedges will run out, exposing the weaker unerlying profit stream.  There’s no sense in paying for profits that will be gone in a quarter or two.  On the other hand, while firms always reveal hedges that have gone wrong (and argue that investors should ignore these losses), they don’t always highlight hedging that has worked.  I guess I’m saying that I’d be leery of companies with EU exposure even if reported profits don’t show any unfavorable impact.