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 Sunday Age.
Twitter @moneypotts
Frequently Asked Questions about this Article…
Predicting the Australian dollar is tough because it requires judging both Australia’s outlook and that of the rest of the world at the same time, and markets move on future expectations. Economists and forecasters often get currency calls wrong, so timing a move in the Aussie usually comes down to luck rather than certainty.
Currency moves can matter a lot: about one-third of the earnings of the top 200 listed Australian stocks are denominated in US dollars, managed funds holding overseas shares are exposed to exchange rate swings, and even property prices can be influenced by foreign buyers or expats reacting to big currency shifts.
The article suggests it’s generally safer not to let currency forecasts drive your investing because forecasts are unreliable. Rather than trying to time the dollar, focus on longer-term fundamentals—though some people might accelerate plans like overseas holidays if they expect the currency to move.
Not necessarily. Exporters and large miners can become more competitive when the Aussie falls, but their share prices tend to follow commodity prices more closely than the currency, and falling currency can also raise costs such as interest on foreign‑denominated debt.
Local rates set by the Reserve Bank matter, but so does the US Federal Reserve because the US dollar is the world’s reserve currency. The article notes the Fed’s large-scale liquidity injections (about US$85 billion a month at the time) feed global capital markets and indirectly affect funding costs and the Aussie.
'Reverting to the mean' is the statistical idea that exchange rates tend to drift back toward their long‑term average over time. The long‑term average of the Aussie is around US75¢, but getting back to that quickly would imply a much larger move (toward US60¢) or an extreme economic shock—so mean reversion is possible but not guaranteed or timely.
Valuation comparisons such as The Economist’s Big Mac index offer a rough, intuitive gauge of currency value; the article notes that by that measure the Australian dollar looked slightly overvalued. These tools are a starting point but shouldn’t be the sole basis for investment decisions.
Many boards avoid taking an outright punt on the currency and will hedge at least some foreign‑currency contracts to reduce volatility. For investors, that means company profits may be insulated from small exchange rate moves, but hedging also has costs and businesses remain exposed to factors like commodity prices and foreign interest costs.
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