A Strong Dollar Means These Countries Are 'On Sale'

David Sterman's picture

Monday, March 23, 2015 - 1:30pm

by David Sterman

The commodity slump of the past few years, divergent growth rates between the United States and other developed economies and a sudden glut in crude oil have been dominating the headlines. Yet the major U.S. stock markets indexes continue to toil near all-time highs.

It's not a coincidence. The United States has clearly become a safe port in stormy seas, and many of the world's leading hedge funds and sovereign wealth funds are selling assets abroad and doubling down on U.S. stocks.

As a perhaps unintended side effect, the surging dollar has absolutely decimated a wide range of other currencies. And that spells opportunity as a wide range of global securities can now be had for fire-sale prices, at least in dollar-denominated terms.

Too Soon?
While the dollar continues to rally, many assume it is wise to let the process play out before starting to pick up assets among the global carnage. Yet we may be closer to the end of the currency shifts than many realize. Right around the time the Fed acts (perhaps in June) "it will be embedded in the dollar" said Jens Nordvig, Nomura's global head of currency strategy, to The Wall Street Journal. At that point, WSJ notes, "The dollar could then stabilize or give back gains against some currencies."

History suggests that the dollar's strengthening phase is already sowing the seeds of its own eventual reversal. That's because a strong currency alters trade balances by reducing exports and increasing imports. In effect, our trade deficit is likely to soon go out of whack, as we suck in more imports. That will blunt our economic growth rates, as import displacement reduces GDP. Our market and currency's appeal is directly tied to the perceived vigor of the U.S. economy.

And it works the other way as well.

Take Turkey as an example. The Turkish lira has fallen sharply over several quarters, which is a likely factor in a recent report showing that Turkey's current account deficit in February was smaller than expected. Indeed Turkey's currency may begin to rebound now that its weak currency has set the stage for shrinking imports and rising exports. Also, Turkey, like many other oil-consuming emerging markets, is now benefiting from the sharp drop in crude oil.

Not only have Turkish stocks been lagging many other emerging markets, but their returns have been even further dampened by conversion back into dollars for U.S.-focused exchange-traded funds (ETFs). Said another way, Turkish stocks are fairly inexpensive on their own merits and will also get a currency-induced lift when the dollar frenzy starts to die down.

Closer to home, the Mexican peso has fallen roughly 20% against the dollar since last June. Note that Mexico is the second-largest export market for U.S. goods (behind Canada) and is our third-largest market for imports (behind China and Canada). Countries on both sides of the border are feeling the impact of the radical currency shift. The move may explain why seven global auto makers have announced plans in the last year to establish new factories in Mexico.

In effect, a weaker peso should help boost Mexican exports to the United States and many other markets. Meanwhile, the Mexico iShares ETF (NYSE: EWW) has slumped to a recent $59.50 from $72 last summer. That fund owns a wide range of Mexican banking and industrial firms, all of which should benefit from a currency-induced economic expansion.

For longer-term investors, know that emerging markets such as Mexico have demographics on their side. Per capita income in Mexico has risen to $10,670 in 2014 from $7,900 in 2009. That sets the stage for rising domestic consumption, which dovetails with increasing industrial output. A 20% currency drop in the peso since last summer provides a clear tailwind to those trends.

Investors may also want to give a fresh look at Indonesia, who's currency, the rupiah, is now trading at levels not seen since 1998. The fact that Indonesia's central bank made a surprise move by cutting interest rates in February helped the currency make another leg down. But the rate cut also signals lessening concern about inflation, especially as oil prices have plunged.

Meanwhile, the Organization for Co-operation and Economic Development (OECD), predicts that the Indonesia economy will grow at least 5% in 2015 and 2016, more than double the global average. For U.S. investors, a falling currency has made Indonesia a scary place to invest, but the iShares MSCI Indonesia ETF (NYSE: EIDO), which owns a range of banking, telecom and consumer staples firms, should benefit from the country's increasingly competitive currency.

Risks To Consider: This is not to suggest that emerging markets -- and their currencies -- can't fall further. Indeed emerging markets should always be owned with a multi-year time horizon, due to their high volatility.

Action To Take --> We don't know when the dollar will reverse course. But such a move is inevitable, based on pressures such as purchasing power parity. U.S.-made goods are now more expensive than before on global markets, which should have the impact of blunting our economic growth, while boosting growth in countries that can pursue a currency-led export boom.    

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David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.