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The world, from the perspective of the US-focused investor, looks pretty bright right now. The unexpected strength of the US economy, buoyant stock prices and the gradual revival of deals have put Wall Street in an optimistic mood about its domestic market.
“I would say the vast majority of investors, my clients around the world, when I asked them about the US, they said, ‘I’m overallocated to the US, but I’m going to allocate more capital to the US.’ “Uh.” ‘” Carlyle boss Harvey Schwartz said at the Milken Institute’s annual meeting this week.
He shared the stage with, among others, Citigroup leader Jane Fraser, who shrugged off concerns about high stock market valuations. He pointed to the two narratives that have driven stocks higher in recent months, noting that if growth remained strong, that would give stocks a reason to rally, while if the economy slowed and interest rate cuts were considered imminent, stocks tended to rise at that time. , also.
However, not all clouds have lifted, especially for investors looking abroad. Geopolitical risk is a constant in investor conversations, as are the challenges of navigating changes in economies that move at different paces. The clearest expression of this is the return of exchange rate coverage to the agenda.
“For a long time, investors didn’t have to worry much about currencies,” Karen Karniol-Tambour, co-chief investment officer at hedge fund Bridgewater Associates, said at the Milken conference. She said she had spoken to investors who talked about large recent investments, but lamented how currency movements had distorted them.
The yen is the most obvious example, which in the last month has suffered dizzying fluctuations against the dollar. It has advanced to Y3 in just a few minutes, due to suspicion of intervention by the authorities to stop its fall. Karniol-Tambour, noting its effect on Japanese stocks: “Japan has had an incredible performance, an incredible performance, if you’ve thought about your currency exposure and said, ‘I don’t want it.'”
Over the past year, the Japanese currency has fallen almost 13 percent as local authorities have very gradually moved away from super-loose monetary policy, while the dollar has been buoyed by higher interest rates for longer. than expected.
This has left an unhedged dollar-based investor tracking the Topix benchmark index with a total return of 17 percent over 12 months. Those who were fully protected gained just over 30 percent, outpacing the S&P 500’s gains.
Hedging can be a means to improve returns, but for many, discussions have revolved around protecting against the risk of unforeseen shocks. “It’s not that investors think the dollar is going to depreciate anytime soon. They are using it as a hedge against geopolitics rather than betting against other countries,” said Elizabeth Burton, client investment strategist at Goldman Sachs Asset Management.
Burton says about a third of institutional investors hedge currency risk. “[They] “We may not need a currency hedge right now, given the strength of the dollar, but implementing it now could put us in a better position if it weakens in the future.”
It’s a difficult balance for investors more accustomed to thinking of the dollar as a haven in times of trouble and as a beneficiary of the American “exceptionalism” argument that has developed over the past decade as its markets have outperformed others.
Still, large swings in the dollar in either direction have the potential to disrupt investment strategies. Bank of America analysts this week noted the need for U.S. companies to also consider their currency exposure, in case the dollar continues to rise, which would weaken their profits once overseas revenues are converted to dollars.
“Although our forecasts still point to eventual dollar weakness in the medium term, the turning point has become more difficult to time,” they wrote to their clients. “The case for hedging dollar upside risks through the rest of the year has increased substantially for U.S. companies.”
Current contracts to buy dollars in the future imply a discount to the spot price against many other major currencies. That means the price of the dollar is at a lower level against, say, its Canadian counterpart for transactions for delivery in November than it is now. The BofA team estimates that, based on recent prices, there is about an 80 percent chance that buying greenbacks six months from now with the Canadian dollar, as the Canadian currency is known in the markets, will give its fruits.
Hedging costs, but the more the world’s large economies move at different paces, the harder it is to justify doing without them.
jennifer.hughes@ft.com