Tag Archives: currency

Shaping a portfolio for 2015 (iii): currency movements

December 8, 2014 By in currency effects, Shaping a portfolio for 2015, Strategy Tags: , , , , , Leave a comment

When economies are deviate from the path that government policy would like them to follow, two basic options are available to get them back on track:

–internal adjustment, meaning the government alters tax/spending/interest rate policy to speed up/slow down the pace of growth; or

–external adjustment, meaning it changes policy with the aim of strengthening/weakening the currency.

In almost all cases, raising interest rates or raising taxes creates economic hardship and makes voters angry.  In bad times politicians have an overwhelming preference for external adjustment through currency movements, because the pain can’t be traced back to a given legislator’s votes.

rising/falling currency

A rise in a country’s currency acts like an increase in interest rates.  It slows down economic activity.  A decline in the currency does the opposite.

Either move has the secondary effect of shifting the composition of growth, as well.  A strong currency increases national wealth; it favors importers and hurts exporters and import-competing industries.  A weak currency does the opposite.

Right now, the EU and Japan are both following weak currency strategies aimed at simulating growth by devaluing their currencies.  In contrast, the US is about to begin the process of raising interest rates to wean its economy away from the emergency monetary stimulus it began in 2009.  The withdrawal of extra money will result in higher interest rates.  These differing policies are already having an effect on relative currency values, and therefore on publicly traded securities.

stocks in a weak currency country

The weak currency tends to stimulate overall economic activity.  Therefore, surprises in domestic earnings growth will tend to be positive–and good for stock prices.  Investors will also seek to benefit from foreign currency strength (i.e., the US$) by rotating their portfolios toward strong currency earners.  These will either be multinationals with significant operations/assets in the strong currency country or exporters.  They will also tend to shun importers, whose offerings will be more expensive and therefore less attractive.

stocks in a strong currency country

Holders of strong currency assets get more bang for their buck in buying weak currency goods and services (like vacations).  They are better off simply from the fact of local currency appreciation.  But for the local stock market, the currency appreciation isn’t an adulterated plus.  Quite the opposite.

The appreciation slows down domestic economic activity, making negative earnings surprises a greater possibility.  In addition, the strong currency value of a firm’s foreign (weak currency) earnings and assets is diminished.   Both will mean that year-on-year earnings comparisons in foreign operations will be unfavorable.  Neither is easy to predict, so the possibility of earnings disappointment will increase.

Therefore, holding stocks in a strong currency country isn’t always just a walk in the park.

Stock market participants typically deal with this issue by rotating their holdings toward importers and purely domestic firms.

other investor influences

carry trade

Weak currency fixed income investors may shift their holdings toward strong currency sovereign bonds.  We’re seeing this already being done this year by EU portfolio managers, who are buying Treasury bonds in large amounts.  To them buying Treasures seems like shooting fish in a barrel.  They get an immediate yield pickup plus a potential currency gain.

EU alternative investors can amplify their returns by shorting their own sovereign bonds and using the funds to buy Treasuries.  That’s the carry trade.

Although the Fed controls the overnight-money Fed Funds rate, foreign portfolio investors may well keep long-term US interest rates lower than they would be if domestic investors were the only market participants.

foreign investment

Foreigners may judge that the currency gain they achieve by buying US stocks will more than offset possible stock price softness due to slower earnings growth. There’s no general rule I know of to decide whether this is a good move or not.  In the 1980s, the return on Mexican stocks was fabulous, even though the peso lost virtually all its value during the decade.  Japanese stocks were also super in the same time frame, even though the currency was very strong.

for 2015

My experience is that traders in the currency markets are way ahead of me in evaluating where currencies should be.  I think I’m better off concentrating on general trends–orienting my active stock holdings in the US toward strong currency beneficiaries and my foreign positions toward weak currency beneficiaries.

One other tactic is to try to find companies that are growing fast enough that currency won’t matter much  (see my post on Pandora).

One final note:  the 1997 Asian economic crisis was triggered by dollar strength.  Many regional firms had borrowed extremely heavily in dollars because interest rates on local debt were much higher.  Balance sheets were destroyed when the dollar appreciated.  If there’s similar trouble in 2015 look for it in South American and Africa, not Asia.

 

 

 

the euro at $1.30–what’s a stock investor to do?

September 4, 2014 By in currency effects, Current Market Thoughts, EU financial crisis, negative interest rates Tags: , , , , , Leave a comment

The €, which had been on a steady rise vs the US$ since spending time at around the $1.20 level two years ago, has been sliding again, after peaking at $1.39 in May.

Several related reasons:

–anemic economic growth, which has conjured up in investors’ minds the specter of deflation and begun to evoke comparisons of the EU with 1990s Japan

–political troubles with Russia and Ukraine, which have created higher uncertainty and lower trade flows, and

–further cuts in interest rates by the ECB to address the persistent economic weakness.  Today’s include a reduction in the equivalent of the Fed Funds rate from 0.15% to 0.05%, and in increase in the penalty fee for keeping deposits with the ECB (instead of lending out the money) from 0.1% to 0.2%.

The important thing for equity investors to note is that the financial markets are reacting to the bad economic developments by selling the currency rather than by selling €-denominated stocks and bonds.  The latter two have been rising in € terms, rather than falling.  The decline against the $ and £ has been about 6% since the peak in May, and about 4% against the yuan.

The currency decline will likely end up being a much larger spur to economic growth than the interest rate cut, which is all about numbers that are basically zero already.  But currency declines rearrange the focus of growth, as well as promoting growth overall.  Export-oriented and import-competing industries are relative winners: purely domestic companies, like utilities, are relative losers.   Typically, too, the currency decline comes in advance of the positive equity reaction.

So, I think it’s time to look at Continental Europe-based multinationals again.  This “good” news doesn’t apply, of course, to their UK-based counterparts, since sterling has been steady as a rock against the dollar recently.

The flip side of this coin is that US- or UK-based multinationals that have large businesses on the Continent have lost a significant amount of their near-term allure.

 

 

recent currency movements

October 24, 2013 By in Constructing a Portfolio, Current Market Thoughts, economics, Portfolio management, Recent Market Action, Stock ideas, Strategy Tags: , , , , , , , Leave a comment

Big macroeconomic changes that affect the relative investment attractiveness of countries vs. one another can play themselves out in two ways:

–changes in the local currency value of the country’s investable assets, and/or

–changes in the value of the country’s currency.

The easiest way to see this is to look at Japan.  The election of Prime Minister Shinzo Abe and the enactment of wide-reaching policy changes he campaigned on have produced two major effects so far:

-a one-year gain of 60% in the yen value of the Japanese stock market and

–a 20% fall in the yen against the US$.

The net result for a ¥-oriented investor is a bonanza–and more joy than the Topix has seen since the 1980s.  For a $-oriented investor, however, it’s a 28% gain.  That’s not much better than the 22% advance in dollars the S&P 500 achieved over the same span.

Looking more closely into the Japanese stock market, weak-yen beneficiaries (exporters and import-competing firms) have been rocket ship rides; domestic-oriented firms, especially those that use dollar-priced raw materials, have languished.

But this is old news.  What’s happening today?

The big movements I see are in the euro and the US dollar.

Over the past three months, the EU currency is up by 4% against the dollar and by 2% against the yen.  The dollar, in contrast, is down against everything except the Canadian currency.  It’s off by 5% against sterling, 4% against the euro, -3.5% against the Australian dollar, -2% against the yen, and -1% against the renminbi.

I think currencies are reflecting two main things:

–primarily, the belief that the EU is finally past the worst economically and is beginning the slow road back to recovery.  Same thing for the UK, only more so.

–secondarily, loss of faith in the US because of worse than usual policy paralysis in Washington.

The big question for investors of all stripes is whether we are in early days of a trend reversal or whether what we’re seeing is just white noise, or random currency movements that may soon reverse themselves.   The answer has important implications for portfolio positioning.

I’m in the former camp.  This means that in Europe, like in Japan a year ago (but on a smaller scale), I should be shifting away from foreign currency earners and toward users of foreign currency-denominated inputs.  I should be doing the opposite in the US.  So far, I’m only changing my (relatively minor) holdings in European stocks.  But I’m worming up to do more.

defaulting on the government debt: what it would mean

October 4, 2013 By in Balance of Payments, bond market, currency effects, Current Market Thoughts, Recent Market Action, reserve currency, securities markets Tags: , , , , , , , , , Leave a comment

debt ceiling crunch time

According to the Washington Post, the letter Treasury Secretary Jack Lew recently sent to Congress said that in mid-October, the Treasury will reach the legislatively imposed upper bound on borrowing to pay for goods and services that Congress has ordered up.   That’s a problem, because Washington’s spending so far this year has exceeded its income by about $100 billion a month–and that’s even after the sequester kicked in.

D-Day is October 17th.

The Treasury figures it will have $30 billion on hand on that date.  Bills coming due can reach as high as $60 billion in a single day.  The current layoff of large numbers of Federal employees through the Tea Party-created shutdown might “save” $5 billion a month, but that doesn’t move the needle much.

what if Congress doesn’t act?

If Congress doesn’t raise the debt ceiling, two related problems arise:

–someone has to decide who gets paid and who doesn’t.  The biggest chunks of spending are Social Security, Medicare/Medicaid, the military and interest on the Federal debt (which alone averages about $33 billion a month), and

–inevitably there’ll come a day when the till is empty and the Treasury either misses an interest payment or, more likely though a rollover timing issue, a principal repayment on Treasury securities.  That’s a default.

what default would mean

Secretary Lew is saying that a government debt default could/would create an economic crisis bigger than the bank failures of 2008.

Yes, I think the inevitable default that would come from not raising the debt ceiling would be a major shoot-yourself-in-the-foot moment for the country.  Worse than 2008, though?

…unless we’re talking about possible very long-term consequences, I think this is possible but not probable.  On second thought, minimizing the damage would require Congress to realize what an idiotic thing it had done and “cure” (as the technical term goes) the default immediately.  The more reluctance by Washington to do so, the closer to the Lew scenario we get.

Default would have several important negative consequences:

slower economic growth

–by not paying on time, the US would establish itself as an unreliable borrower.  Lenders, both foreign and domestic, would therefore demand a higher interest rate for the use of their money.  How much higher?  That depends a lot on Congress, but basically no one knows.

–given Washington’s dysfunction, the only effective tool of macroeconomic policy the country has is the Fed.  To at least some degree, the Fed would lose its ability to influence rates if investors begin to regard Treasuries as risky securities.  That’s not good.

weaker currency

–the move among emerging countries to replace the dollar as world currency with, say, the renminbi, would kick into higher gear.  This would risk the US losing the perks of being the world’s banker–lower interest rates, ease of borrowing.

–in extreme circumstances, global buyers and sellers might lose enough confidence in the dollar that they’d refuse to accept it in trade.  This might freeze global commerce in the same way that was so devastating to the world in late 2008-early 2009, when firms wouldn’t take bank letters of credit.  That could be really ugly.

 

There is, of course, the issue that adding $1 trillion+ a year to the Federal debt isn’t a sustainable plan for financing the Federal government.  And business-as-usual Washington has no tolerance for addressing the holy trinity of budget-busters–the military, Social Security and Medicare/Medicaid.  Still, puling the house down around everyone’s ears isn’t a great solution, either.