By Doug Sandler, Chris Konstantinos & Rod Smyth, RiverFront Investment Group
Last week we further reduced our exposure to international markets in our shorter time-frame portfolios and invested the proceeds in U.S. stocks. This was a risk management trade reflecting their continued relative underperformance. Two inter-related things are working against non-U.S. stocks in dollar terms:
- Trade war fears and now the meltdown in the Turkish currency, economy and stock market are having a disproportionate effect on stocks in Asia and Europe.
- Uncertainty is leading to a stronger dollar, which lowers the return on foreign stocks to U.S. investors.
THE DOLLAR HAS RISEN SINCE THE END OF Q1:
Following a 15 month rise by most foreign currencies against the U.S. dollar from January 2017 until March 2018, all of the currencies shown in the chart below (Japanese Yen, Euro, Chinese Yuan and a basket of emerging market currencies) have fallen, with the most dramatic declines seen in emerging market currencies. We attribute this to uncertainty surrounding global trade, and high visibility of stronger growth in the U.S. as the result of lower taxes and de-regulation in 2017.
Past performance is no guarantee of future results.
A U.S. holder of non-U.S. investments has two components to their return; the price of the investment and the exchange rate. We have observed that outperformance of non-U.S. markets (in dollar terms) tends to occur during periods when the dollar is either moving sideways or down. During periods of dollar strength, U.S. markets are much harder to beat. We had a trading range view of the dollar for 2018 and so the magnitude of the dollar’s strength, especially against emerging market currencies has surprised us. We expect the dollar to weaken if the trade disputes are favorably resolved and when U.S. growth starts to slow.The former may not occur, though we think it will. The latter is probably a 2019 story.
TROUBLE IN TURKEY:
Turkey was in financial trouble well before President Erdogan and President Trump started fighting over extradition issues, which led to threats of sanctions. The Turkish lira has fallen 42% in 2018 and lost a fifth of its value versus the dollar just last week. While European banks do have some exposure to Turkey (more than other global banks) the market’s reaction on Friday suggested to us that traders and leveraged investors were bailing out. There will likely be an opportunity to return to the markets that are getting hit the most, but for now we are respecting the trends.
RISK MANAGEMENT AT RIVERFRONT:
While our strategic preferences are mostly driven by relative value, our risk management discipline is mostly driven by price momentum. Therefore, we tend to have the biggest allocations to asset classes where value and momentum are aligned. This was the case for international stocks in 2017, but momentum has swung back to U.S. stocks in 2018 and we have responded accordingly, lowering our exposure to international stocks 5 times since the end of Q1.
THE WEEKLY CHART: RELATIVE UNDERPERFORMANCE BEGAN IN MAY
Doug Sandler, CFA, is Global Strategist; Chris Konstantinos, CFA, is Chief Investment Strategist; and Rod Smyth is Director of Investments at RiverFront Investment Group, a participant in the ETF Strategist Channel.
Important Disclosure Information
The comments above refer generally to financial markets and not RiverFront portfolios or any related performance. Past results are no guarantee of future results and no representation is made that a client will or is likely to achieve positive returns, avoid losses, or experience returns similar to those shown or experienced in the past.
Information or data shown or used in this material is for illustrative purposes only and was received from sources believed to be reliable, but accuracy is not guaranteed.
In a rising interest rate environment, the value of fixed-income securities generally declines.
Investing in foreign companies poses additional risks since political and economic events unique to a country or region may affect those markets and their issuers. In addition to such general international risks, the portfolio may also be exposed to currency fluctuation risks and emerging markets risks as described further below.
Changes in the value of foreign currencies compared to the U.S. dollar may affect (positively or negatively) the value of the portfolio’s investments. Such currency movements may occur separately from, and/or in response to, events that do not otherwise affect the value of the security in the issuer’s home country. Also, the value of the portfolio may be influenced by currency exchange control regulations. The currencies of emerging market countries may experience significant declines against the U.S. dollar, and devaluation may occur subsequent to investments in these currencies by the portfolio.
Foreign investments, especially investments in emerging markets, can be riskier and more volatile than investments in the U.S. and are considered speculative and subject to heightened risks in addition to the general risks of investing in non-U.S. securities. Also, inflation and rapid fluctuations in inflation rates have had, and may continue to have, negative effects on the economies and securities markets of certain emerging market countries.
RiverFront Investment Group, LLC, is an investment adviser registered with the Securities Exchange Commission under the Investment Advisers Act of 1940. The company manages a variety of portfolios utilizing stocks, bonds, and exchange-traded funds (ETFs). RiverFront also serves as sub-advisor to a series of mutual funds and ETFs. Opinions expressed are current as of the date shown and are subject to change. They are not intended as investment recommendations.
RiverFront is owned primarily by its employees through RiverFront Investment Holding Group, LLC, the holding company for RiverFront. Baird Financial Corporation (BFC) is a minority owner of RiverFront Investment Holding Group, LLC and therefore an indirect owner of RiverFront. BFC is the parent company of Robert W. Baird & Co. Incorporated (“Baird”), a registered broker/dealer and investment adviser.
These materials include general information and have not been tailored for any specific recipient or recipients. Accordingly, these materials are not intended to cause RiverFront Investment Group, LLC or an affiliate to become a fiduciary within the meaning of Section 3(21)(A)(ii) of the Employee Retirement Income Security Act of 1974, as amended or Section 4975(e)(3)(B) of the Internal Revenue Code of 1986, as amended.
Index Definitions:
MSCI EAFE Index is an equity index that captures large and mid cap representation across developed markets countries around the world, excluding the U.S. and Canada.
Standard and Poor’s (S&P) 500 Index measures the performance of 500 large cap stocks, which together represent about 80% of the total U.S. equities market.
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