This week I’d like to address the important effect currencies have on investment returns. As we have often stated, successful investing today requires adopting a global view (hence the “Global” in Global Investment letter). As a result, along with diversification, which provides greater opportunities and reduces risk, successful investing today requires the careful monitoring of a host of variables such as currency exchange rates. Investing in assets denominated in strong currencies can provide a significant boost to returns, as I’m sure you know. Indeed, even if investors restrict themselves to investing domestically (which we do not recommend) the effect of changing currency values will be felt both in the local economy and by domestic companies with international operations.
It’s an important concept we all know, but like many others, there is value in being reminded of it so that it stays front of mind. I find that is certainly the case with me.
In November 2015, I wrote an article entitled “The Best Investment for the Next 5 Years” (available in the free commentary section of our website under the heading Capital Markets) in which I suggested that U.S. denominated assets would outperform alternatives based on my expectation that the US dollar would be the strongest of the major currencies. That view, based on economic, and perhaps even more importantly, on geopolitical considerations, has worked out very well thus far as illustrated by the chart of the US dollar index above.
But where do we go from here?
The ill-conceived trade war with China initiated by the Trump administration has potentially significant geopolitical consequences. As well, there remains the threat that the Trump administration will implement protectionist trade measure against the European Union and Japan as well. The trade war with China, and perhaps other trading partners, can be expected to act as a brake on global economic growth.
However, the trade war, in addition to creating economic and geopolitical turmoil, will also likely continue to fuel a stronger US dollar for the short to medium term. Not only will the enormous size of the American economy and domestic market mitigate the effects of a trade war on the U.S. relative to its trading partners, but it is also likely that American trading partners will devalue their currencies to offset the effect of tariffs.
The trade war with China, and its potential eventual escalation to trade wars with other nations, will present both opportunities and threats. The effect of tariffs will punish some companies and sectors and benefit others. As we move forward, it will be more important than ever to take a broader view in investing, as the threats and opportunities presented by trade conflict will cross borders. Upcoming issues of the Global Investment Letterwill be identifying companies and sectors impacted by trade disputes, both positively and negatively.
Global trade is emerging as a potential catalyst for the dramatic events we anticipate in the years ahead.
On behalf of your editor and the rest of the Global Investment Letter team,
Editor & Publisher