Major Currencies vs. Their Stock Markets

03/20/2014 9:00 am EST

Focus: CURRENCIES

It’s not easy to predict a currency’s direction, but you can still do yourself a favor by being aware of the prevailing monetary policy in the country in which you are seeking exposure, advises Stoyan Bojinov of ETFdb.com.

When it comes to foreign equity exposure, many investors tend to dismiss, or simply aren’t aware of, the impact that foreign currency exchange fluctuations can have on their investments’ bottom-line returns. The fact of the matter is that in many cases a country’s currency can be a direct driver of stock market returns, while other times the relationship between the two can be unexpectedly uncorrelated if not altogether inversely-related.

In light of the recent five-year US bull market anniversary, we’re taking a stroll down memory lane and reviewing how major currencies and their stock markets, as represented by ETFs, have fared since the bottom. Our reference point for the so-called bottom is March 6, 2009, which in hindsight was the turning point for the S&P 500 Index.

Note that the performance charts below are compiled using cumulative monthly returns with adjusted closing prices from March 2009 through March 2014, thereby offering a five-year snapshot of how major currencies have fared in relation to their nation’s respective equity market.

US Dollar vs. the S&P 500 Index
Consider the performance comparison of the US dollar, as represented by the PowerShare’s (UUP), and the S&P 500, as represented by State Street’s (SPY).

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The US stock market’s run-up has been quite impressive at the expense of a depreciating currency, as evidenced by UUP’s persistently negative cumulative returns since the bottom. Unprecedented stimulus measures from the Fed coupled with ultra low-rates have been the driving forces behind the greenback’s decline since the start of this bull market.

Euro vs. the MSCI EMU Index
Consider the performance comparison of the euro, as represented by Guggenheim’s (FXE), and the Eurozone’s equity market, as represented by iShares’ (EZU).

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The euro ETF and EZU were fairly positively correlated from the bottom through the middle of 2011. This relationship started to deteriorate to an extent, however, prior to the beginning of 2012 when the ECB began to slash rates again; since then, falling interest rates have dragged on the euro’s performance while equities have been bolstered in light of the ECB’s growing commitment to spur economic growth in the gloomy currency bloc.

British Pound vs. the MSCI United Kingdom Index
Consider the performance comparison of the British pound, as represented by Guggenheim’s (FXB), and the UK stock market, as represented by iShares’ (EWU).

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The British pound has been able to remain in positive territory since the bottom, turning in a much more impressive and consistent performance than its developed cousins, the euro and the US dollar. One reason behind this relative outperformance is the fact that the Bank of England stopped slashing rates in March of 2009, and as a whole, the BoE’s stimulus efforts haven’t been as massive as those of the other major central banks.

Japanese Yen vs. the MSCI Japan Index
Consider the performance comparison below of the Japanese yen, as represented by Guggenheim’s (FXY), and the Japanese stock market, as represented by iShares’ (EWJ).

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NEXT PAGE: 3 Emerging Market Currencies

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The yen boasted a very positive relationship with the Japanese stock market right up until the Bank of Japan embarked on a massive stimulus plan of its own following Shinzo Abe’s general election victory in December of 2012; since then, “Abenomics,” which refers to the newly enacted fiscal stimulus, monetary easing, and structural reforms, has bolstered the nation’s equity market much higher, at the expense of a steeply depreciating Japanese yen.

Aussie Dollar vs. the MSCI Australia Index
Consider the performance comparison below of the Aussie dollar, as represented by Guggenheim’s (FXA), and the Australian stock market, as represented by iShares’ (EWA).

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The Aussie dollar rose alongside the country’s stock market right from the bottom, showcasing a very strong positive correlation between the two. This relationship began to deteriorate towards the beginning of 2012, however, when the Reserve Bank of Australia started slashing rates again to combat sluggish economic growth; this is evidenced by the fact that the Aussie dollar ETF has since stagnated and fallen, whereas the nation’s equity market, as represented by EWA, has been able to continue its ascent amid the currency’s devaluation.

Brazilian Real vs. the MSCI Brazil 25/50 Index
Consider the performance comparison below of the Brazilian real, as represented by WisdomTree’s (BZF), and the Brazilian stock market, as represented by iShares’ (EWZ).

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The real rose in nearly perfect lock-step with the equity market from the market bottom; the direct relationship between the two has persisted through today, although positive momentum has evaporated and both assets have endured steep declines since the currency peaked in mid-2011. Brazil’s central bank has been raising rates since the start of 2013, but this has yet to reverse the currency’s and EWZs’ steep downtrends.

Indian Rupee vs. the WisdomTree India Earnings Index
Consider the performance comparison below of the Indian rupee, as represented by WisdomTree’s (ICN), and the Indian stock market, as represented by WisdomTree’s (EPI).

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The rupee has endured a similar fate as the real since the market bottom, although its relationship to the country’s stock market has not been as strongly correlated. India’s central bank has been steadily hiking interest rates since early 2010, but this hasn’t been able to reverse the rupee’s downtrend, and its stock market has followed it lower, further showcasing the positive correlation between the two assets.

The Bottom Line
It’s important to take note of the inherent currency risk that comes with investing in overseas markets, as fluctuations in the foreign exchange market can have a meaningful impact on bottom-line returns. While it’s no easy task to predict the direction of a currency, investors can still do themselves a favor by being aware of the prevailing monetary policy in the country in which they are seeking exposure; remember that rising interest rates generally correspond to a stronger currency, while the effect on the stock markets’ performance can vary from country to country depending on factors like exports and raw materials prices.

By Stoyan Bojinov, Contributor, ETFdb.com

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