Neil Macneale, is well known for compiling an ongoing model portfolio based on companies that have a...
Use the "fear trade" to your profit by buying overseas stocks with over-valued dollars
06/05/2012 8:30 am EST
But if currencies aren’t on that already long list, I think they need to be. And if you’ve only been watching the U.S. dollar and the euro, you need to expand your list.
Understanding which currencies have been rising and which falling will help you understand the recent performance in individual financial assets and for assets such as commodities and gold.
And that currency performance will also help you pinpoint some markets that will deserve a bit of your cash not too far down the road. The current short-term turbulence and the big move in the U.S. dollar versus almost all other global currencies created by the current flight to safety have overwhelmed longer term fundamental trends. The rise of the dollar in the short term, I’d argue, has created some interesting bargains in the medium term and in the longer term not just for currency traders but also for investors in global stocks.
An overvalued dollar—on its fundamentals—will, whenever the dust clears sufficiently, enable you to by non-dollar assets at bargain prices.
You’ve undoubtedly been following the U.S. dollar, especially against the euro. That exchange rate has been a major driver, of course, of prices in the commodities markets. As the dollar has climbed the price of oil and other commodities prices in dollars has fallen because it takes fewer of these more valuable dollars to buy a barrel of oil. And it has been a big part of the reason for the drop in gold prices and in the value of financial assets such as European stocks priced in euros.
Even after a slight gain against the dollar on Friday, June 1, after the disappointing U.S. jobs report, the euro was down 7.6% against the dollar since the 2012 high on February 28 and down 15.3% since June 7, 2011.
And that’s had the effect of depressing stocks priced in euros. Certainly a European luxury goods stock such as LVMH Louis Vuitton Moet Hennessy (MC.FP in Paris and LMMUY in New York) has its shares of worries that a European recession and slowing growth in China will reduce sales of luxury goods, but the dollar certainly hasn’t helped. During the period from June 7, 2011 when the euro was falling 15.3% against the dollar, the New York traded shares of Louis Vuitton fell 16.45%.
Of course, the dollar has been climbing against more than just the euro. Many of these other currencies have held up relatively well against the dollar until relatively recently.
The Australian dollar, for example, is down 11.5% from its 2012 high on March 1 through June 2. Its total decline against the dollar over the last year isn’t a whole lot steeper at 13.6% from its 2011 high on July 28. The big damage has come in the last month or so with the Australian dollar falling 7% from April 30 through June 1.
The bulk of global currencies show a similar pattern of decline against the dollar with the decline accelerating in the last few months. For example, the Brazilian real is down 24.5% against the dollar as of June 1 from its July 25, 2011 high. But more than half of that is from the 2012 high on February 28. From that date through June 1 the real is off 16.9%.
The Canadian dollar, which climbed regularly from December 19, 2011 to April 27, 2012 (a gain of 5.9%), has given it all back and a bit more since then with a 6.03% drop that has taken the loonie back to the levels it saw last November.
Even the Chinese yuan has dropped against the dollar—or to be exact the People’s Bank has let China’s currency drop against the dollar. The yuan declined 0.9% against the U.S. dollar in May. Part of that is a reflection of a decision by the central bank to let the yuan depreciate against the dollar inside its official trading range so that Chinese exports would gain an edge in world markets because they would cost less to overseas customers. (The big problem here is with the euro. Since the yuan is effectively linked to the dollar, the rise of the dollar against the euro has made Chinese exports more expensive in Europe, China’s biggest export market. Letting the yuan depreciate against the dollar is a way to slow the yuan’s gains against the euro.) The yuan has also been under some pressure because the pace at which wealthy Chinese move money out of China has increased after the purge of Bo Xilai on April 30.
Not all of this drop against the dollar has been a result of the euro debt crisis leading currency traders and portfolio managers to seek the safety of the U.S. dollar and U.S.-dollar-denominated assets such as Treasuries. Some of the drop in these currencies has been the result of negative developments in individual domestic economies. For example, the drop in the Canadian loonie comes as Canada’s own economy (so closely linked to that of the United States) has slowed and increased odds of an interest rate cut by the end of 2012. (By reducing what investors get paid for holding assets denominated in Canadian dollars, an interest rate cut decreases the demand for assets denominated in Canadian dollars and thus reduces demand for Canadian dollars themselves.)
Similarly, the Brazilian economy has had difficulty in gaining traction after the Banco Central do Brasil raised interest rates in 2010 and early 2011 to slow the economy and reduce inflation. Since August 2011, however, the bank has been cutting rates. On Wednesday, May 30, the central bank cut interest rates again—by 0.5 percentage points—to a historic low of 8.5%. The bank has now reduced rates by a full four percentage points since it began cutting rates in August 2011. The Brazilian real has, by and large, followed the benchmark Selic interest rate downward.
In Australia the central bank is expected to cut interest rates from the current 3.75% to 2.75% by the end of 2012 in order to stimulate an economy that is slowing in lockstep with softening Chinese demand for industrial commodities.
In Mexico, where the peso has declined by 12.4% against the dollar since March 13, the currency has moved down recently with data showing slowing growth in the United States and polls on the July presidential election that suggest the leftwing Party of the Democratic Revolution is closing the gap with the centrist (but once itself leftwing) Institutional Revolutionary Party (PRI) and that the rightwing National Action Party (PAN) is falling to a weak third place.
So what does all this mean to you?
I’d argue that the euro debt crisis has led to a global fear trade that has pushed the U.S. dollar to a higher price than is justified on the medium- and longer-term fundamentals of the U.S. budget deficit, U.S. political grid lock, and U.S. economic growth. That same fear trade has pushed down the currencies of countries such as Brazil, Australia, Mexico, Canada, Chile (the Chilean peso is down 7% from May 3 to June 1), Norway (the krone is down 9.2% from February 28 to June 1) and Sweden (the krona is down 9.9% from February 28 to June 1) to levels that discount the better fundamentals of those economies.
At the moment that means you can use over-valued U.S. dollars to buy under-valued assets in the real, the Australian dollar, the Mexican and Chilean peso, the Canadian loonie, the Norwegian krone, the Swedish krona and other currencies.
In the long run you will be able to add the appreciation of those currencies against the dollar to whatever gains assets in those markets record.
In a global financial market where what I’ve labeled the Paranormal Economy will make 5% a year look like a great return, I don’t think investors can afford to ignore this kind of potential gain from currency swings. (For an outline of the Paranormal Economy see my March 2 post http://jubakpicks.com/ )
The big question, of course, is When? When will the dollar stop climbing on troubles in the euro zone? When will the global fear trade turn into a sporadic trade rather than the only trade? When will what I think are real but temporary problems in the economies of Brazil, Mexico, Canada, Chile, Norway, Sweden and Australia make the turn toward improved growth and stable interest rates?
I think I can sketch in some currency price levels that I’d like to see before I dip my toe into these trades. For example, the euro at $1.20 would get my interest (although I know there are currency analysts on Wall Street who are talking about parity between the euro and the dollar.) The Australian dollar, to take another example, has support at 94.50 to 95 cents. (It finished June 1 at 96.49 cents.) The consensus seems to be that the Banco Central do Brasil has stopped trying to force down the real and will even look to defend the currency near current levels.
I can also sketch in a vague calendar. I think we’re looking at interest rate cuts to draw to a close in Brazil, Canada, and Australia in the third quarter. Sweden and Norway might see one more cut as the central banks in those countries try to keep their currencies from appreciating so much that they hurt exports. The U.S. presidential race will be over in November and financial markets can begin to focus on how/whether/when the U.S. will begin to deal with its budget deficit.
All that could—and I stress “could”—mean that we will see global currency markets start to move away from the dollar and toward these fundamentally stronger currencies in the last quarter of the year. That would mean buying the stocks of these stronger currencies markets in November or so.
The euro debt crisis is, of course, the great wild card. A true solution that took fears of a Spanish default out of market calculations would swing the markets against the dollar more quickly as money managers realized they didn’t have to pay up for the safety of dollar-denominated assets. On the other hand, a failure to come up with anything resembling a solution in the Greek crisis so that Greek is forced to default and/or leave the euro and a failure to offer Spain anything except the path currently walked by Greece, Ireland, and Portugal would lead the euro to plunge through $1.20 and fear would push the dollar higher against all the currencies I’ve mentioned.
In other words, I think it’s still time to wait. As much as I like this over-valued dollar/under-valued non-dollar currencies trade, I don’t think the risk reward ratio is yet slanted in my favor. It’s time to research what to buy—and I’ll continue to add suggestions to my watch list http://jubakpicks.com/ —rather than to execute this strategy.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of LVMH Louis Vuitton Moet Hennessy as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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