Movements in the Canadian dollar can significantly affect your clients\u2019 returns on foreign investments. For the most part, Canadian investors benefited in 2008 as the C$ dropped against the U.S. dollar, the euro and the yen. But 2009 may be a different story.
One reason is the expected increase in oil prices once global economic growth picks up. Because oil is what interests most inves-tors when they think of Canada, the C$ is a petrodollar \u2014 it tends to move in lockstep with the price of oil.
Another reason is that many global money managers expect the US$ to weaken, but not dramatically, against most currencies, including the C$ and the euro. That means returns on U.S. equities could be somewhat dampened, in C$ terms, this year, while returns on investments in Europe may not be affected as drastically.
In addition, there is some potential for dampened returns on Japanese stocks. Analysts expect the Bank of Japan<\/b> to intervene in exchange markets to lower the value of the yen, which is hurting the competitiveness of Japanese exporters at its current level. But Japanese equities tend to be a small part of most Canadians\u2019 foreign holdings.
All this suggests your clients shouldn\u2019t be too concerned about exchange-rate movements this year, Indeed, most money managers are recommending that clients seek broad geographical diversification.
Rather, the risk is in investing solely in Canadian equities. The Canadian market is small when measured by capitalization \u2014 less than 3% of total global market capitalization. Our domestic market is also concentrated in a few sectors; Canada does not have many publicly traded companies in sectors other than resources or financial services. If clients stay at home, they can miss the best investment opportunities, as well as exposure to sectors with strong growth prospects.
Here\u2019s a look at what\u2019s expected for some of the world\u2019s key currencies over the next few years:
> US$.<\/b> The greenback surprised many people by strengthening against many currencies in 2008 \u2014 not just those of resources producers such as Canada, whose currencies decline with drops in commodities prices. The US$ finished 2008 up by 23.9% vs the C$ year-over-year and up by 23.1% vs the yen, but down by 4.7% vs the euro.
Most market analysts say the rise in the US$ is due mainly to a flight to safety in a period of uncertainty. The greenback is still the major global currency and, as such, is considered the safest place to be when economies everywhere slow markedly or are in a recession.
The question is: how long the US$ will stay at current levels? There are three theories suggesting that the US$ will return to, at least, pre-2008 levels.
The first theory is that the U.S. has huge structural problems that will take years to correct as U.S. financial services institutions and American consumers slowly lower their debt and rebuild their balance sheets. This will translate into slow economic growth, even in the recovery, and will discourage investment in US$-denominated investments. Global money managers adhering to this view include Ross Healy, president of Toronto-based Strategic Analysis Corp., <\/b> and Nandu Narayanan, chief investment officer with Trident Investment Management LLC<\/b> in New York and manager of several mutual funds offered by CI Investments Inc.<\/b>of Toronto.
The second theory is that a lower greenback will be needed to keep U.S. exports competitive. Otherwise, the U.S. current account will shoot back up once the prospect of economic recovery pushes oil prices higher and U.S. cash registers start ringing again. The scenario here pictures a gradual decline in the US$ as investors move more of their assets into investments denominated in other currencies.
The third theory is that the huge amounts of money that fiscal stimulus is pumping into the U.S. economy will cause inflation to roar back once the economy begins to grow. The resulting scenario pictures a flight to gold, on the theory that gold will keep its value while the purchasing power of paper currencies falls.
However, there are also market analysts \u2014 independent financial and economic consultant Lloyd Atkinson in Toronto, for one \u2014 who think the US$ will keep its recent gains and maybe climb a little higher. There are two theories here.
The first is that U.S. stocks will not only lead the way in the recovery but also continue to perform well through the next cycle, thereby attracting global investors to U.S. equities and, thus, increase demand for U.S. dollars. This is based on the theory that the U.S. remains the most resilient and innovative economy, something that is confirmed by the history of the past 20 years.
@page_break@The second theory is that the deep recession currently hitting the U.S. should permanently bring the current account down to manageable levels, particularly if growth in consumer spending is relatively modest in the initial recovery period, as households repair and rebuild their balance sheets.
> Euro. <\/b> At yearend 2008, the euro was up by 18.1% vs the loonie and up by 52.5% vs the yen. Although the euro has the potential to be a reserve currency, it has yet to achieve that status. The problem is the structural inflexibility (particularly in labour markets) of the European economies, which will keep growth in Europe relatively sluggish for the foreseeable future. The result is relatively muted demand for euros.
However, there are some market analysts who believe that Europe is becoming less inflexible and has more growth potential than others believe. If that\u2019s the case, the euro may rise more than expected.
It should be noted that European companies won\u2019t welcome further increases in the euro because that makes it harder for their exports to compete overseas, as well as making European goods less competitive against imports at home.
> Yen. <\/b> Japanese companies won\u2019t welcome a higher valuation of the yen, which is why the Bank of Japan is expected to intervene in exchange markets to bring its value down.
The rise in the yen in 2008 was based on a reversal of what\u2019s called the \u201ccarry trade,\u201d which involves Japanese investors investing in fixed-income instruments denominated in other currencies that pay higher interest than those offered in Japan. But as interest rates plunged around the world, these Japanese investors repatriated their investments, thereby increasing the demand for the yen.
The carry trade may re-emerge with the return of healthy global growth, as Japan is likely to experience less inflationary pressures than other countries, given sluggish domestic demand.\t IE<\/b>
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