Bank of Canada Governor Mark Carney worries that the rapid rise of the loonie may prolong the recession. Beleaguered manufacturers fret over the effect of the strong dollar on exports. Prime Minister Harper and Ontario Premier McGuinty fear that the currency surge may wipe out all the hard-won concessions in their battle to salvage Chrysler and General Motors. Yes, currency angst reigns at the highest levels in the land.
But while the bankers and the politicians agonize, what's the ordinary investor to make of all this? Is a strong loonie good or bad for your portfolio? And how do you factor in the effect of currency movements in making your investment decisions? There are no easy answers but I have some suggestions.
Before I get to them, here's a quick recap on what has happened. According to the Bank of Canada, on Jan. 21, 2002 the Canadian dollar hit its lowest point since the Second World War, at US61.79c. That meant it cost almost C$1.62 to buy one U.S. greenback. Some analysts were predicting the loonie would fall even more with one prominent economist saying it could drop all the way to US25c. Not surprisingly, there was a lot of talk about abandoning the loonie entirely and adopting the U.S. dollar as our own currency.
But then something surprising happened. The loonie not only stabilized but it began a five and a half year run that took it all the way to US$1.103 on July 11, 2007. At that point, you could literally buy U.S. greenbacks for 90c on the dollar (90.66c to be precise). Some economists were saying our currency could go as high as US$1.25.
That didn't happen either. The loonie began to slide and by July 2008 it was back to parity. Then, as world oil prices crashed, our dollar followed them down, hitting a recent low of US76.53c on March 9 of this year. It cost almost C$1.31 to buy a U.S. dollar at that time.
But the price of oil started to recover and guess what? The loonie followed. You can argue all you want that our dollar should not be treated as a petro-currency but international money traders are telling us otherwise. As the price of oil approached US$70 a barrel, the loonie touched a 2009 high of US92.69c last week, up 21% since the March low. It has retreated since but with Goldman Sachs now predicting that oil will hit US$85 by the end of this year and US$95 in 2010, few people would want to bet against a continued rise in the loonie. Based on past experience, setting specific targets is a mug's game but parity within a year certainly seems to be a strong possibility.
What is especially disconcerting about all this is the rapidity at which these changes are occurring. No one gets overly upset over orderly, long-term currency movements. But exchange rate shifts of 20%+ in less than three months make any kind of intelligent planning almost impossible.
We'll leave it to Mark Carney and Stephen Harper to figure out how to deal with the problem on a macro level. But on a micro level, investors must decide how they will cope with the currency uncertainties in terms of their own accounts.
It's not an easy call. One of the classic rules of investing is to diversify your portfolio, both in terms of asset classes and geographically. Every investor should have some exposure to the U.S. market, the theory goes, because the Canadian market is so narrowly based and has few companies of truly international stature. I've been an advocate of owning some U.S. stocks or mutual funds for years but the unprecedented exchange rate moves we have seen have made this strategy somewhat problematic.
A look at a few key numbers explains why. Since New York's S&P 500 Index hit a 52-week low of 666.79 in March, it has rallied by about 40% in U.S. dollar terms. But once you take the currency loss into account, the net gain to a Canadian who bought the index is less than 20%. By comparison, the S&P/TSX Composite Index is also up about 40% in the same period, in Canadian dollars. Where would you rather have your money?
So what should you do in this situation? Here are some options to consider. Note that these only relate to the Canada-U.S. exchange rate; overseas investing brings a different set of variables into play.
Stay out of the U.S. market. If the Canadian dollar is going to continue to rise, that approach makes a lot of sense at first glance. But there are two flaws in the strategy. First, no one can predict with certainty where the loonie will be in a year. If the anticipated economic recovery hits a bump, oil prices will drop again and we could see a renewed flight to the safety of U.S. Treasuries. That would push the loonie back down almost as quickly as it rose and add to the value of any U.S. assets in your portfolio.
Even more important, staying out of the U.S. would mean cutting yourself off from the world's largest and most active stock market. Even discounting the currency loss, some American stocks on our Recommended List have produced big gains recently. In mid-May, contributing editor Glenn Rogers advised taking half-profits in STEC Inc. (NDQ: STEC), which had jumped 71% in the month since he picked it. Amazon.com (NDQ: AMZN) is up more than 15% in less than a month since we formalized that recommendation. PepsiCo (NYSE: PEP) is ahead more than 10% since we updated it with a buy signal in May. The leveraged ProShares Ultra Basic Materials ETF (AMEX: UYM) is ahead more than 80% since we advised buying in a March update. Yes, you need to pick your spots carefully but if you choose to stay out of the U.S. market all these possibilities would be closed to you.
Ride the currency waves, up and down. Some people believe they can take advantage of currency rates by switching the assets in their portfolios according to the trends. Good luck with that approach. If you were able to predict last March that the loonie would turn on a dime and be back over US90c by June you should be a professional foreign exchange trader. You'd make millions!
The reality is that even the best economic minds in the country can't make currency calls with any degree of accuracy and they have access to data we never see. Timing currency moves is even more difficult than timing the stock market. You will almost certainly get it wrong.
Ignore exchange rate fluctuations: they'll even out over time. I've heard this advice from several professional money managers. Perhaps it's true but to my mind it's worthless. What does "over time" mean? It took more than five years for the loonie to rise from US62c to US$1.10. Then it took only 20 months to drop back to US76.5c. Now, three months later, we're back in the US90c range. This is hardly "evening out". And if and when we do even out, where exactly will the loonie be? Back at US62c? That seems unlikely. So forget the "evening out" theory. It means nothing.
Hedge your currency bets. There are ways to invest in the United States while protecting your portfolio against currency moves. Several mutual fund companies now offer "currency neutral" versions of their major U.S. equity funds. You can achieve the same effect with some ETFs such as the iShares CDN S&P 500 Index Fund (TSX: XSP), which is hedged back into Canadian dollars. For large accounts, currency futures contracts can be used as a form of portfolio insurance.
In the end, you have to decide whether currency moves are going to play a major role in your investment choices. For readers who spend time in the U.S. (or plan to do so after retirement) the decision is a little easier because they will need American dollars in any event. Those who don't plan to do much travelling south of our thickening border should limit their exposure to U.S. securities, at least at this point. Adding currency risk to market risk probably isn't worth it in that situation.
But while the bankers and the politicians agonize, what's the ordinary investor to make of all this? Is a strong loonie good or bad for your portfolio? And how do you factor in the effect of currency movements in making your investment decisions? There are no easy answers but I have some suggestions.
Before I get to them, here's a quick recap on what has happened. According to the Bank of Canada, on Jan. 21, 2002 the Canadian dollar hit its lowest point since the Second World War, at US61.79c. That meant it cost almost C$1.62 to buy one U.S. greenback. Some analysts were predicting the loonie would fall even more with one prominent economist saying it could drop all the way to US25c. Not surprisingly, there was a lot of talk about abandoning the loonie entirely and adopting the U.S. dollar as our own currency.
But then something surprising happened. The loonie not only stabilized but it began a five and a half year run that took it all the way to US$1.103 on July 11, 2007. At that point, you could literally buy U.S. greenbacks for 90c on the dollar (90.66c to be precise). Some economists were saying our currency could go as high as US$1.25.
That didn't happen either. The loonie began to slide and by July 2008 it was back to parity. Then, as world oil prices crashed, our dollar followed them down, hitting a recent low of US76.53c on March 9 of this year. It cost almost C$1.31 to buy a U.S. dollar at that time.
But the price of oil started to recover and guess what? The loonie followed. You can argue all you want that our dollar should not be treated as a petro-currency but international money traders are telling us otherwise. As the price of oil approached US$70 a barrel, the loonie touched a 2009 high of US92.69c last week, up 21% since the March low. It has retreated since but with Goldman Sachs now predicting that oil will hit US$85 by the end of this year and US$95 in 2010, few people would want to bet against a continued rise in the loonie. Based on past experience, setting specific targets is a mug's game but parity within a year certainly seems to be a strong possibility.
What is especially disconcerting about all this is the rapidity at which these changes are occurring. No one gets overly upset over orderly, long-term currency movements. But exchange rate shifts of 20%+ in less than three months make any kind of intelligent planning almost impossible.
We'll leave it to Mark Carney and Stephen Harper to figure out how to deal with the problem on a macro level. But on a micro level, investors must decide how they will cope with the currency uncertainties in terms of their own accounts.
It's not an easy call. One of the classic rules of investing is to diversify your portfolio, both in terms of asset classes and geographically. Every investor should have some exposure to the U.S. market, the theory goes, because the Canadian market is so narrowly based and has few companies of truly international stature. I've been an advocate of owning some U.S. stocks or mutual funds for years but the unprecedented exchange rate moves we have seen have made this strategy somewhat problematic.
A look at a few key numbers explains why. Since New York's S&P 500 Index hit a 52-week low of 666.79 in March, it has rallied by about 40% in U.S. dollar terms. But once you take the currency loss into account, the net gain to a Canadian who bought the index is less than 20%. By comparison, the S&P/TSX Composite Index is also up about 40% in the same period, in Canadian dollars. Where would you rather have your money?
So what should you do in this situation? Here are some options to consider. Note that these only relate to the Canada-U.S. exchange rate; overseas investing brings a different set of variables into play.
Stay out of the U.S. market. If the Canadian dollar is going to continue to rise, that approach makes a lot of sense at first glance. But there are two flaws in the strategy. First, no one can predict with certainty where the loonie will be in a year. If the anticipated economic recovery hits a bump, oil prices will drop again and we could see a renewed flight to the safety of U.S. Treasuries. That would push the loonie back down almost as quickly as it rose and add to the value of any U.S. assets in your portfolio.
Even more important, staying out of the U.S. would mean cutting yourself off from the world's largest and most active stock market. Even discounting the currency loss, some American stocks on our Recommended List have produced big gains recently. In mid-May, contributing editor Glenn Rogers advised taking half-profits in STEC Inc. (NDQ: STEC), which had jumped 71% in the month since he picked it. Amazon.com (NDQ: AMZN) is up more than 15% in less than a month since we formalized that recommendation. PepsiCo (NYSE: PEP) is ahead more than 10% since we updated it with a buy signal in May. The leveraged ProShares Ultra Basic Materials ETF (AMEX: UYM) is ahead more than 80% since we advised buying in a March update. Yes, you need to pick your spots carefully but if you choose to stay out of the U.S. market all these possibilities would be closed to you.
Ride the currency waves, up and down. Some people believe they can take advantage of currency rates by switching the assets in their portfolios according to the trends. Good luck with that approach. If you were able to predict last March that the loonie would turn on a dime and be back over US90c by June you should be a professional foreign exchange trader. You'd make millions!
The reality is that even the best economic minds in the country can't make currency calls with any degree of accuracy and they have access to data we never see. Timing currency moves is even more difficult than timing the stock market. You will almost certainly get it wrong.
Ignore exchange rate fluctuations: they'll even out over time. I've heard this advice from several professional money managers. Perhaps it's true but to my mind it's worthless. What does "over time" mean? It took more than five years for the loonie to rise from US62c to US$1.10. Then it took only 20 months to drop back to US76.5c. Now, three months later, we're back in the US90c range. This is hardly "evening out". And if and when we do even out, where exactly will the loonie be? Back at US62c? That seems unlikely. So forget the "evening out" theory. It means nothing.
Hedge your currency bets. There are ways to invest in the United States while protecting your portfolio against currency moves. Several mutual fund companies now offer "currency neutral" versions of their major U.S. equity funds. You can achieve the same effect with some ETFs such as the iShares CDN S&P 500 Index Fund (TSX: XSP), which is hedged back into Canadian dollars. For large accounts, currency futures contracts can be used as a form of portfolio insurance.
In the end, you have to decide whether currency moves are going to play a major role in your investment choices. For readers who spend time in the U.S. (or plan to do so after retirement) the decision is a little easier because they will need American dollars in any event. Those who don't plan to do much travelling south of our thickening border should limit their exposure to U.S. securities, at least at this point. Adding currency risk to market risk probably isn't worth it in that situation.
