If you are not a participant in the investment world, the capital markets this week, specifically the stock market, resembled a confused soul who could not make up their mind between abject despondency and unbridled jubilation. For the week, the market was down nearly 100 points, but the bottom line does not tell you how we ended up where we did. In speaking to astute individuals, many comment about how investors always talk about downturns in the market as an 'opportunity'. Still, if one does not look at lower prices of assets as a potential chance to buy something which is worth X for less than X, potentially far less than X, say .7X or .6X, or even better, why would anyone pay attention to the fluctuation in asset prices? So, if we cannot call lower prices an 'opportunity', what might we refer it to? Some say a gift, some a curse. Depends on who is looking at the prices and what it is they are looking at, don't ya think?
Within this prism, I want to turn our attention to the idea of currency strength (weakness) and how it can affect equity markets. From my perspective, when the domestic currency of a country strengthens against the other currencies in the world, equity markets of the home country benefit. Let's take a look at some different examples to see what I am referring to. From 1990-2000, the U.S. stock market had maybe the best period in its history as the average gain was nearly 20% a year. Now, the period was culminated by the internet boom and bust, so there are clearly other factors which helped contribute to the result, but this was also a period when the U.S. dollar was strong. From 2000-2008, equity markets in the U.S. did not return very much to owners, other than dividends, and this period was marked by dollar weakness.
In looking at other countries, Japan has suffered from a lost decade in its equity market, to this day continuing to suffer from deflation. During the last 5 years, countries which have been heavily dependent on energy and commodity exports have seen their equity markets rise dramatically, along with having strong currencies. Russia, Brazil, Canada, and Australia are the most prominent examples. Now the world is experiencing a downturn in the cycle, and these countries have seen their currencies and equity markets tumble, especially in the last six months.
The key point I want to emphasize is a countries currency strength or weakness is based on a number of variables, but a major one is how quickly it is growing, usually based on GDP growth. Countries which have a large and widely diversified economy benefit from having many sources of growth. Those which are reliant on one or two prime industries, like energy or commodities, clearly suffer when those areas are suffering from a slowdown in demand too much capacity. Another key factor is the current account, which is very much dependent on the trade surplus or deficit. In the United States, the major reason for its large current account deficits has been, until recently, the reliance on foreign oil imports. As we are all well aware of, that situation has changed, and dramatically. Because of greater U.S. self sufficiency for energy production, trade deficits, and fiscal deficits as well, have been shrinking dramatically. All in all, with the United States appearing to be the country which is clearly benefiting from stronger growth than many other developed regions, a stronger dollar is probably going to be with us for a while. A strong dollar is good for investors of the home country, and historically one can look at the facts to see the correlation is generally pretty reliable. No guarantees from the management, and do your own research, and certainly, correlation is not causation.
Another topic which one has to address in thinking about the current equity market environment is uncertainty. It is well known investors hate an uncertain future. With the terrible tragedy in France, geopolitics again was thrown in as a factor which can help unsettle markets. The prospects of a highly contentious relationship between Congress and the big O (zero?) for the next two years seems pretty high, if not certain, so gridlock is probably the best investors can hope for. Historically, a do nothing political situation is typically not such a bad thing for investors, but the lack of any kind of a functioning government clearly does not inspire confidence. As an example of this, when you add in what the FCC chairman, Tom Wheeler, announced by saying there would be a vote on 'Net neutrality' at the end of February, predictability is not the hallmark of our fine leadership. What it does do is throw another variable into the equation which makes investing less certain. No help coming on the political front, that is for sure, but, you knew that already after six years of this, ahem, guidance.
Turning to the specific of the markets, last week saw retail in focus as Bed Bath & Beyond Inc (NASDAQ:BBBY) delivered a poor result, and the Container Store (NYSE:TCS), ever consistent in its mediocrity, continued to have issues. JC Penney Company (NYSE:JCP) delivered a nice surprise, albeit nobody expected much anyway. Oil and energy related names are stuck firmly in the doghouse with no bones in site. Gold showed a bit of a pulse with a little uptick on Friday, but dollar strength does not help the shiny yellow substance. Biotech continues to be the rage as earnings and cash flow are properties of large enterprises like Gilead Sciences Inc (NASDAQ:GILD), which showed a nice gain this week on an agreement with CVS (NYSE:CVS).
Looking ahead to next week, the earnings parade starts as Alcoa Inc (NYSE:AA) kicks us off and then the financials take over, with Wells, Chase, and Goldman later in the week. The low, low, and lower interest rate policies certainly do not help the banks, but don't worry about those guys, as we all well know, they make plenty of scratch in many ways.
Disclaimer: Y H & C Investments, Yale Bock, and the family of Yale Bock own positions in securities mentioned in the blog post. Investing in stocks can lead to the complete loss of your capital. As always, on any company mentioned here, past performance is not a guarantee of future returns. Investing involves risk of losses on invested capital. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charter holder.