Swimming With The Currency
Where were U.S. investors better off last year: In the Dow Jones Industrial Average, down 34% or the Nikkei 225, down 42%? Strangely, the latter.
Currency volatility was so extreme in 2008 that in many cases it outweighed the effect of judicious international equity allocations. For dollar-based investors, the Nikkei was down only 29%, thanks to the soaring yen.
The impact for sterling-based investors was even more pronounced. They lost only 3% on Japanese equities, as the British currency slumped.
There is of course a flip side. Dollar-based investors in the FTSE 100 lost half their money in 2008, despite the index falling only 31% for the year. And those that were lured into outperforming emerging-markets funds during 2007, discovered that some of the strength was fueled by the weak dollar. The Brazilian Bovespa index rose 44% in local currency that year, but 72% in dollar terms. In 2008, the story reversed. The Bovespa fell 41% in local currency and 55% in dollars.
The violent currency swings show little sign of disappearing as uncertainty over the economic outlook remains. The dollar fell 13% against the euro in little more than two weeks in early December before strengthening again recently.
Currency moves can't be ignored for the above reasons. Also, for heavily export-oriented countries such as Japan and Germany, the currency can have a significant impact on the profits of individual companies. With the yen and the euro both strong -- and recessions under way among importing nations -- businesses domiciled in those countries are under pressure.
In the same way, companies with large international operations benefit from translation impacts if their home currencies are weak. That inflates international profits, at least superficially, when translated back to local currency. That is the case for U.K.-based groups right now.
How should equity investors react? One option is to take the view that currency moves are inherently unpredictable -- and the key is to have enough geographic diversification to mitigate the severest impacts. Another is to hedge out exposure. The cost of the latter has fallen, now interest-rate differentials have narrowed around the world.
Finally, they can take a straight currency bet. For example, those who believe the recent rebound in equity markets is real -- and the global recession will be less painful than widely feared -- could use currencies to try juicing equity returns (or losses if they are wrong).
Take the U.K. and Korea. They are heavily exposed to the health of the global financial system and international trade. Both saw heavy stock-market losses and respective currency falls of 27% and 25% against the dollar last year
For the brave, that could make them a leveraged bet on recovery. |
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