The curse of predicting currency fluctuations
After all, it requires a simultaneous assessment of the outlook for Australia and that of everybody else. As is always the case with markets, it's not enough to look at what's already happened, either - you have to look ahead. In this case twice: at us and everybody else.
Trouble is, you can't really ignore the currency. About one-third of the earnings of the top 200 listed stocks are denominated in US dollars, for instance.
And don't even ask about managed funds in overseas shares or other assets.
Heck, the dollar even influences property prices. It might be expatriates buying - or selling, as the case may be - because of a big currency move. Or, say, investors from Hong Kong snapping up another apartment block or two.
Did I mention interest rates? Bet you thought the Reserve Bank and/or the banks controlled them. But that's only half the story.
Just as important is the US Federal Reserve, which prints the world's reserve currency at the rate of $US85 billion a month. This is the source of the liquidity in international capital markets from which our own banks raise half their money.
There's no shortage of expert predictions about where the dollar is going. Try 80-something US cents for starters.
Except economists are the first to admit, since they don't have much choice, that they're worse at tipping where the dollar is going than anything else.
Not that they're so hot on interest rates or GDP growth either, but this is no time to be picky.
Still, they do have a handy trick up their sleeves. This is what's called "reverting to the mean", which isn't a personality switch but a tendency for values to veer back to their long-term average. That is, they return to form.
There's no reason they should, mind you, but it happens to be a statistical fact, so they may as well make the most of it.
The long-term average of the dollar is about US75¢, but there's a complication. It's been around or above parity for some time, so to get to that average quickly it would have to spend some time closer to US60¢, which would require either a surging US dollar or some economic doomsday scenario.
Another way of looking at it is that exchange rates should make the price of something the same everywhere after you've done the currency conversion. The respected Economist magazine, for example, famously compares the price of a Big Mac because it tastes the same wherever you buy one. No reflection on the local offering, but on the basis of burgerology our dollar is slightly overvalued.
Anyway, just because some of our best economic minds say the dollar can only drop even further, they're not suggesting it should influence your investing, though to be on the safe side maybe you should bring forward the family holiday to Disneyland.
True, among listed stocks, exporters, especially the big miners, as well as online-challenged retailers, should be winners. But not as much as you'd think.
It's a brave board that would take an outright punt on the dollar by not hedging at least some foreign-currency denominated contracts. And while they'll undoubtedly be more competitive, some costs such as the interest on debt might also rise.
In fact, resources companies "tend to trade more in line with their respective commodity price" than the currency, according to a report by RBS Morgans.
And the outlook for commodity prices is not good. Just ask Treasury. Besides, when all is said and done it's the strength of the global economy, not to mention ours, that matters in the end.
It's much safer to forget what the currency will do which, you never know, might be nothing.
Read David Potts in Weekend Money, with
The Sun-Herald, every Sunday.
Twitter @moneypotts
Frequently Asked Questions about this Article…
No — the article stresses that nobody can know for sure where the dollar is going or when, and getting that call right often requires luck. Economists themselves admit they are poor at forecasting exchange rates, so currency prediction is unreliable for investors.
The dollar matters because roughly one‑third of the earnings of the top 200 listed stocks are denominated in US dollars, and currency moves can affect managed funds, overseas investments and even property prices when foreign buyers react to big swings.
The article suggests most boards avoid taking an outright punt on the currency and will hedge at least some foreign‑currency‑denominated contracts. Hedging helps manage risks such as variable costs or interest on foreign debt.
Interest rates are influenced by domestic policymakers like the Reserve Bank, but the US Federal Reserve also matters because it supplies global liquidity (noted as about US$85 billion a month in the article), which affects international capital markets and how local banks raise funds.
Not necessarily. The article notes exporters and big miners could benefit, but not as much as you might think. RBS Morgans found resources companies tend to trade more in line with commodity prices than the currency, and the outlook for commodity prices is described as weak.
'Reverting to the mean' is the tendency for values to move back to their long‑term average. The article says the long‑term average of the Australian dollar is about US75¢, but because the dollar has been near or above parity, a quick return to the mean would imply a much lower level — which could require a very strong US dollar or a severe economic downturn.
The article references The Economist's Big Mac comparison — which equalises the price of a standard product across countries after currency conversion — and says that on that basis the Australian dollar looks slightly overvalued.
The article advises caution: because currency moves are hard to predict and may end up doing 'nothing', it's often safer to ignore short‑term currency forecasts and focus on fundamentals rather than making big strategic changes solely based on predicted currency swings.
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