News & Insights
King Dollar Rides Again: Innocent Bystanders Tremble
This quarter our thoughts are focused on the relative strength of the U.S. dollar against the Euro and the Japanese Yen. Our Federal Reserve Bank is making noises indicating the end of the period of extraordinary accommodation that has existed since the financial crisis. This is occurring as Europe and Japan increase monetary stimulus of their domestic economies to address concerns of weak economic growth and the specter of deflation. The U.S., European and Japanese central banks are gargantuan economic players and it would be naïve to think that they could so definitively shift policy relative to one another without some unintended consequences in the stock and bond markets.
As domestic investors anticipate higher U.S. interest rates, the result will be (as the past few weeks have shown us) larger daily swings in the major stock indices. Participants will game the consequences of a stronger dollar. The interest rate arbitrageurs will lick their chops at the prospect of profiting from the “carry trade” to exploit the almost 1.75% difference between the rate paid on long term U.S. Treasuries and German Bunds.
Our view on the stock market has been well telegraphed. We think the S&P 500 is a bit expensive and so recommend a mildly cautious stance. The currency factor adds one more thing to consider. However, while the translation of current overseas profits into rich U.S. dollar terms will depress reported profits of U.S. multinationals, it does little to change the intrinsic value of a well-run business and so we do not counsel a change of strategy based on the change in currency relationships.
Interestingly, the markets most likely to get roiled by dollar, euro and yen dynamics do not reside in the U.S., Europe or Japan. It is the most brittle of members of the emerging markets that will likely suffer the most profound problems from a rising dollar. By brittle we mean those countries with negative trade balances such as Turkey, Chile and South Africa that depend on short term borrowing to fund their deficits. While more robust economies may escape much of the direct effect of these currency fluctuations, history has shown that in the event of a panic sale of emerging market stocks, the healthy markets tend to decline along with the unhealthy markets resulting a general decline across all emerging markets.
Our long-term outlook for emerging markets stocks is bright. Valuations are generally attractive and the growth outlook is strong. They may experience some choppy waters, which we believe could result in a buying opportunity.
The Altavista Investment Team- Spring 2015