PMC Weekly Review - March 20, 2015
A Macro View – The Rise of the Dollar Impact on Equity Markets
Despite Federal Reserve Chair Janet Yellen removing the word “patient” from the latest Fed statement, the Fed continues to signal to the market that they are in no hurry to raise rates. That said, the market has already priced in a strengthening U.S. dollar (USD) over the past year and market participants assume that the Fed will be the first major central bank to begin raising interest rates. The Fed stopped their bond purchase program in October as other central banks have continued further strengthening the dollar. As noted in last week’s commentary, the European Central Bank (ECB) initiated their quantitative easing program while other central banks continue with loose monetary policy hoping to stimulate economic activity. The impact of divergent central bank policies (U.S. versus other developed countries) has already been felt by financial markets and many believe this will continue as the market determines new currency equilibriums which will impact investors in almost every asset class.
The most immediate impact of divergent central bank policy has been on the USD which has appreciated by almost 25% over the past year when using the U.S. Dollar Index which measures the USD against a basket of six foreign currencies1. U.S. investors with exposure to non-hedged foreign assets have noticed their international returns remain lackluster when compared to local currency returns. In both European and Japanese equity markets, the differences between local currency and USD returns were over 10% last year. This year, in Europe, it is around another 10%. Despite what appears to be a pause in the continued strengthening of the dollar this week, many market participants believe the dollar will continue to strengthen at least until parity with the Euro.
While the declining dollar has hurt USD denominated investors in foreign assets, the impact on international equity markets when using local currencies has been strong. The Japanese Nikkei is at a 15 year high, and the UK FTSE 100 and the German DAX are nearing all-time highs. One major contributing factor to this is that all three nations rely on exports in order to sustain economic growth, and a declining currency when compared to the USD helps those exporters competitively price their goods. In addition, we noticed that a large depreciation in a currency can result in a short-term windfall for exporting companies since earnings in local currency will be inflated as revenue increases due to currency depreciation; however, cost, if in the local currency, will remain fixed. Lastly, as some international and emerging market firms have issued debt in USD, their financing costs have increased dramatically. All of these factors could create opportunities within international equity markets as investors will try to determine who will benefit or be hurt by recent currency movements.
For U.S. companies, the impact of a strengthening dollar will also be mixed. Those U.S. companies that rely on exports should see their revenue drop as they will have to lower prices to remain more competitive. Large-cap stocks, which generate a significant portion of their revenue from overseas, will most likely be punished the most in a strengthening dollar environment. That said, U.S. companies that rely on foreign imports from the developing world as part of their input costs will be able to benefit as their costs decrease. Again, investors will need to determine who will benefit most in a strengthening dollar environment.
In conclusion, the impact of the strengthening dollar will ripple across other markets including the equity markets. As many spoke of a new normal given the massive and unprecedented loose central bank policy that has taken place, the impact of these moves continue to be felt by investors.
1 We would note that the majority of this basket is against the Euro which has declined by more than 20% versus the USD on YoY basis.
The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this weekly review is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment strategy. Past performance is not indicative of future results.
Information obtained from third party sources are believed to be reliable but not guaranteed. Envestnet|PMC™ makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.
Investments in smaller companies carry greater risk than is customarily associated with larger companies for various reasons such as volatility of earnings and prospects, higher failure rates, and limited markets, product lines or financial resources. Investing overseas involves special risks, including the volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. Income (bond) securities are subject to interest rate risk, which is the risk that debt securities in a portfolio will decline in value because of increases in market interest rates. Exchange Traded Funds (ETFs) are subject to risks similar to those of stocks, such as market risk. Investing in ETFs may bear indirect fees and expenses charged by ETFs in addition to its direct fees and expenses, as well as indirectly bearing the principal risks of those ETFs. ETFs may trade at a discount to their net asset value and are subject to the market fluctuations of their underlying investments. Investing in commodities can be volatile and can suffer from periods of prolonged decline in value and may not be suitable for all investors. Index Performance is presented for illustrative purposes only and does not represent the performance of any specific investment product or portfolio. An investment cannot be made directly into an index.
Alternative Investments may have complex terms and features that are not easily understood and are not suitable for all investors. You should conduct your own due diligence to ensure you understand the features of the product before investing. Alternative investment strategies may employ a variety of hedging techniques and non-traditional instruments such as inverse and leveraged products. Certain hedging techniques include matched combinations that neutralize or offset individual risks such as merger arbitrage, long/short equity, convertible bond arbitrage and fixed-income arbitrage. Leveraged products are those that employ financial derivatives and debt to try to achieve a multiple (for example two or three times) of the return or inverse return of a stated index or benchmark over the course of a single day. Inverse products utilize short selling, derivatives trading, and other leveraged investment techniques, such as futures trading to achieve their objectives, mainly to track the inverse of their benchmarks. As with all investments, there is no assurance that any investment strategies will achieve their objectives or protect against losses.
Neither Envestnet, Envestnet|PMC™ nor its representatives render tax, accounting or legal advice. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor.
© 2015 Envestnet. All rights reserved.