As the world watches the progress of the US Federal Reserve’s (Fed’s) tapering program, and anticipates the strengthening of the US dollar, we’re often asked how this affects our view of international markets and risk. The short answer is that it doesn’t. We’re long-term, bottom-up stock pickers, so we’re primarily concerned with currency impacts on a company-by-company basis. However, there are some broad trends that are worth noting.
Emerging Asia/Latin America
Fed tapering and the strengthening US dollar are having an impact on emerging markets. Capital is flowing out of these markets as investors increase their allocation to developed markets, and their currencies are weakening, causing current account deficits to become problematic in many countries — Brazil, India, Indonesia, and Thailand to name a few. As a result, these countries are taking actions to stabilize their currencies: raising interest rates, cutting government subsidies, restricting imports and more. These moves are creating near term difficulties because economic growth has already been decelerating, and these actions place even more downward pressure on economic growth.
When investors flee emerging markets, currencies weaken and valuations compress. For long-term investors, this creates the opportunity to buy high-quality businesses with good long-term growth prospects at good valuations.
Historically, a stronger US dollar had not had much of an impact on performance in Europe, as exporters become more competitive and their foreign-currency-based earnings become more profitable. So, we’re seeing net positives for the region in terms of faster earnings growth rates, greater competitiveness and stronger foreign currency-based earnings. The element of growth, and how the market choses to value this growth, is generally more important than the small loss on the currency directly.
It’s difficult to predict the full implications for US investors of a stronger or weaker US dollar. For example, in 2013 the Japanese yen fell about 17% against the dollar, but Japanese equities still returned more than 26% in dollar terms. In contrast, the euro rose by nearly 5% against the dollar, and yet the MSCI Europe Index also returned more than 25% in dollar terms.
So, historically, we have not hedged currencies, nor do we invest simply because we expect currency movements to have a positive impact on a business. However, we understand the impact of currency movements on the economy and how this flows through the financial statements of businesses. We use these impacts to identify potential risks to our holdings, evaluate whether we have the appropriate level of downside protection, and make sure our investment thesis remains intact.
The MSCI Europe Growth Index is an unmanaged index considered representative of European growth stocks. An investment cannot be made directly in an index.
Past performance cannot guarantee comparable future results.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The dollar value of foreign investments will be affected by changes in the exchange rates between the dollar and the currencies in which those investments are traded.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified funds.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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