Gary Larson, the cartoonist, used to drink eight cups of coffee in the morning and then go hang out at the San Diego Zoo for inspiration. Those of us trying to get a fix on the matrix of influences that can impact our investment decisions would do well to go for a blast of caffeine before trying to make sense of the Rubik’s Cube of current financial events.
So, the dollar has weakened by 13 percent relative to foreign currencies in part because we spend more money overseas than foreigners spend here. When there is a surplus of dollars in some country relative to that country’s amount of currency, those dollars sloshing around will go down in value compared with the “host” country’s currency. This is happening in China, which is accumulating dollars of trade surplus at a rate of over $300 billion per year. The president says that they are “manipulating their currency” to keep it cheap compared with dollars, but last Monday, the U.S. Department of the Treasury reported that, on the contrary, our dollars are sinking in comparison with the Chinese yuan.
Yin and yang. A weaker dollar is actually beneficial from a sales standpoint, because, while it makes our purchase of imported goods more expensive, it makes it easier for us to sell our products to foreign buyers. Hopefully, increased sales and profit will offset the “tax” we effectively pay if imported goods cost more. Thirty-five percent of the total sales of the S&P 500 companies are attributable to sales beyond our shores. For example, Caterpillar sells 65 percent of its tractors overseas. Microsoft’s number is 85 percent. Much of the recent strength of our economy has been attributable to the strengthening world economy.
But on the flip side, a weaker dollar will prompt foreign bondholders to hold less of our government debt, because they are losing money if the dollar depreciates when compared with their currencies. Less demand for our bonds will prompt interest rates to rise and this will be bad for bonds and for stocks.
These are just a few factors to consider, yet each component needs to be weighed against other offsetting factors — such as the introduction of tariffs and the possibility of a trade war. What gets overlooked in recent analysis is the economic value of so-called “comparative advantage.” This is the fact that the world economy does best for everyone when each country manufactures and sells what it does best. A combined effort raises the world’s economic tide which, in turn, raises all the boats.
Doing nothing is probably the best course rather than trying to second-guess all of these influences. For those inclined to want to do something, anything, allocating some assets to emerging market funds could be positive. Beyond just “fooling around,” this effort at modest diversification can add what analysts would describe as “inverse correlation” — an investment that tends to zig while everything else zags. A review of emerging markets mutual fund performance over the past 10 years illustrates this point. A typical emerging markets fund has gained over 22 percent over the past 12 months, but the 10-year average annual return is only 4 percent — one of the lowest of any asset class. What this tells us is that this category took a beating early in the 10-year period while the rest of the market snapped back quickly. Now the category is catching up and may sustain some momentum.
For those wanting to invest in emerging markets while avoiding stocks, emerging markets bond funds can be worth considering. Interest rates are relatively high. The idea would be to hold them to perpetuity, spend or invest the interest and ignore fluctuations in capital value.
The missing piece of the Rubik’s Cube, finally, is political instability. With an unprecedented number of high-ranking officials indicted and possibly headed for trial, there’s no telling where it will end and what the outcomes may mean for financial markets. It calls to mind the Gary Larson cartoon where the alligator in court testifies, “Well, of course I did it in cold blood. … I’m a reptile!”