(Bloomberg) -- Six months ago, exchange rates would have mattered less in a global investor’s stock-picking process. Now with the dollar facing what some warn is an existential threat, currencies are in the limelight.
With over 40% of non-U.S. firms’ sales exposed to the world’s reserve currency, according to data from Jefferies (NYSE:JEF) Financial Group Inc., everyone is trying to map how a tumbling dollar re-shapes investment across equities. Some are betting emerging market shares will benefit, others point to value in America, while Japanese stocks are seen lagging should the greenback slide more.
“The fastest selloff in risk assets in history followed by the fastest rally showed extraordinary volatility tied to currency markets, so yes, you’d have to take a view of how these would impact your hedges and equity investments,” said George Boubouras, head of research at K2 Asset Management in Melbourne. “You do have to be cognizant of currency risks far more.”
With the Bloomberg Dollar Spot Index down around 10% since its March high, the challenge for investors lies in determining the depth and longevity of its decline.
The Winners
For New York-based hedge fund manager Thomas J. Hayes, the dollar’s downtrend is a signal to buy riskier EM stocks and commodities.
“Cheap dollar funding encourages risk taking and money flows into perceived ‘higher growth’ locales,” said Hayes, chairman of Great Hill Capital LLC. He favors emerging-market stocks partly as companies will have an easier time servicing dollar-denominated debt.
Equities in developing nations have recorded a consistently inverse relationship with the dollar, with the most profound impact in Latin America, according to Citigroup Inc (NYSE:C). strategists including Jeremy Hale.
“Moves in correlations between Latam equities and the dollar tend to be more pronounced and occur prior to moves in other regions,” they wrote in a recent note. “Emerging market equities are currently underperforming the U.S. relative to historical soft dollar periods, and look good value to outperform should the greenback fall another 10% from here.”
In Asia, Chinese and Hong Kong firms stand to benefit most as the dollar tumbles, according to an analysis earlier this month from Jefferies strategists including Desh Peramunetilleke.
“While exporters to the U.S. are negatively impacted due to a weaker dollar, such periods are usually very supportive of global equities, led by EM/Asia,” the Jefferies team wrote. From a global sector point of view, “cyclicals such as energy, materials and capital goods benefit strongly.”
To be sure, not everyone places currency fluctuations as a core part of their investment considerations. Case in point is Phillip Kim, a portfolio manager at Morgan Stanley (NYSE:MS) Investment Management in Chicago, who said his team is more focused on discussions such as value versus growth.
“We focus on quantitative factor data and fundamentals but currency and fund flows can confirm strength in a particular region or country,” Kim said.
Meanwhile, JPMorgan Chase (NYSE:JPM) & Co. sees a weaker dollar as a reason to favor U.S. stocks. It’s ratcheting up its allocation to American equities as a cheaper currency makes the assets more attractive to foreign investors, while also creating a growth headwind for overseas firms, strategists including Nikolaos Panigirtzoglou wrote in a note this month.
Invesco Ltd.’s Nixon Mak, a strategist, is also a fan of U.S. stocks, even if a weaker currency ends up weighing on their absolute returns for global investors.
“With strong domestic demand and sustainable earnings growth from certain sectors, we believe the U.S. equity market is still favorable now and the currency effect could be offset by the return from capital,” he said.
The Losers
At the other end of the scale, Japanese stocks are often flagged as benefiting least from a weaker dollar. Local currency appreciation can be “problematic” for equity performance in Japan -- and also Europe -- where correlations with the dollar are not as “clear-cut” as those in emerging markets, wrote the strategists at Citi.
“If the dollar is in a structural downtrend, the yen has room to appreciate further and that means Japanese equities will fall to last place on our radar,” said Nader Naeimi, head of dynamic markets at AMP (OTC:AMLTF) Capital Investors in Sydney. “While emerging markets will stand to benefit from a weaker dollar, Japan is the opposite.”
Meanwhile in Europe, though U.K and Russian miners, and e-commerce players have shown strong performance during periods of dollar weakness, Danish biotech stocks, Swiss healthcare suppliers and Dutch food retailers are some of the key sectors that underperform, according to the Jefferies analysis.
“Traditionally the currency effect is minimal with only a maximum 3% to 5% of impact in absolute return,” said Invesco’s Mak. However, the pandemic-induced rout earlier and the change in environment to one of low growth and yield has changed the investment dynamics, he said.
“In this sense, the currency return could become a major component in a total return perspective,” Mak said.
©2020 Bloomberg L.P.