Or, Why Your Canadian Friends Seem Happier
Being in the right investments but in the wrong currency is like swimming against a strong current. No matter how much you think you’re moving ahead, the current keeps pulling you back, impeding your progress or setting you back despite otherwise successful investment choices.
Conversely, being in both the right investments and currency is like swimming with the current, you progress much faster if you swim well, and even if you don’t, you can still move ahead. Even if your investments aren’t the best, if they’re linked to or denominated in the right currency, your net worth keeps moving in the right direction.
For anyone else hurt by the long term USD decline, the need to be aware of long term forex trends and diversify out of the USD is one of the most important and painful lessons of the past few years. Large forex-savvy multinational corporations have been aware of the trouble in recent years, but many smaller businesses and individual investors are only just beginning to awaken to the need for currency diversification. Even though the USD has been in overall decline vs. many major currencies (like the AUD, CAD and JPY) for a decade or more, or many decades (down 75% vs. the CHF since 1970), reputations die hard, and most US investors grew up believing the USD was the safest currency to own, backed by the best economy.
Hey Canada, I Know What You Did Last Decade
Here’s a simple example of why awareness of forex trends is critical for every investor.
Imagine back at the beginning of 2000 an American investor #1 decided to seek currency diversification for his portfolio beyond the US, converted $100,000 USD to CAD, and invested the sum in a basket of Canadian stocks that comprise the S&P/TSX index, an index that tracks the Toronto Stock Exchange. His friend investor #2 took the same sum and invested it in the S&P 500 index.
The USD vs. The CAD: Canada’s Better At More Than Just Ice Hockey
Here’s what happened to the USD vs. the CAD, as shown in the chart below of the USDCAD [click to enlarge images]:
USDCAD JANUARY 2000 – AUGUST 18 2011 08AUG 18 1044
Obviously, we have a strong and overall very steady 10-year downtrend.
Here are the numbers:
USDCAD JANUARY 2000: 1.4478
USDCAD AUGUST 18 2011: 0.9839
% CHANGE: +32.04%
So, since January 2000, investor #1 gained 32.04% over investor #2 just on currency appreciation.
Equities: Canada Is Not Japan
Of course if you don’t have the right investments in a given currency, you still could lose. For example, if you sold US dollars and bought the Japanese Yen in 1990, you did even better than with the CAD in the above example.
Here’s the USDJPY chart from May 1990 – August 2011:
USDJPY MONTHLY CHART MAY 1990 – AUGUST 17 2011 03 AUG 17 2046
Again, another obvious long term downtrend for the USD, this time vs. the JPY.
Here are the numbers:
USDJPY MAY 1990: 159.47
USDJPY AUGUST 2011: 76.45
NOMINAL CHANGE: 83.02
PERCENT CHANGE: 52%
However, if you invested your Yen in the Nikkei, look what happened:
NIKKEI 225 1990 –AUGUST 201110 chart courtesy of Yahoo.finance.com AUG 18 1546
Your 52% gain in currency appreciation was more than counteracted by a nearly 75% drop in the Nikkei over the same period.
Meanwhile, look how your US dollars performed if invested in the S&P 500 over the same period:
NIKKEI 225 Vs. S&P 500 1990 – AUGUST 2011 13 AUG 18 1550
The 52% currency loss was more than made up for by the vast outperformance of US stocks during this period, particularly during 1990-2000.
However, things went better for Canada. Note how the representative index of Canadian shares fared vs. the S&P 500, a good barometer for US stocks (and risk assets in general):
S&P/TSX COMPOSITE INDEX JANUARY 4 2000 – AUGUST 15 2011 04 AUG 18 1008
CHART COURTESY OF YAHOO.FINANCE.COM
The TSX composite basket of stocks rose almost 50% since January 2000 to mid-August 2011. Meanwhile the S&P 500 lost 20% in this same period.
For example: If in January 2000 you converted $100,000 USD to CAD, then invested that in the S&P/TSX composite index or similar basket of stocks -
$100,000 USD put into CAD in 2000 became $132040.
That $132040 invested in stocks grew to be about (132040*1.5 =) $198060
That $100,000 USD invested in the S&P in 2000 became about $ 80000
% Gain From Putting $100,000 USD into CAD and Canadian stocks: 147.57%
In sum, our sample passive investor #1 who went with Canadian currency and stocks benefitted from both currency AND stock trends for a combined gain of 147.57% ahead of investor #2, who stuck with US currency and stocks.
Of course, the above does not consider dividends. However, as I wrote about in my early – mid 2009 posts on seekingalpha.com there are a lot of great dividend paying Canadian stocks. See links below at the end of this article.
Is It Too Late To Ride These Trends?
Clearly, we need to discuss equity and currency trends separately. Both topics are vast, so we’ll only give the most basic summary.
US vs. Canadian Stocks
As the above chart comparing the 2 indexes exemplifies, while global stock indexes move together in the same general direction, they don’t necessarily move to the same degree. Canadian stocks moved higher in the boom years and retained their overall advantage through the bad years. Canadian stocks are more heavily weighted to commodities, especially energy. How these sectors do will obviously affect stock performance. However as we note below, while the Canadian economy is heavily tied to that of the US, its fundamentals are better.
In sum, expect Canadian and US stock markets to head in the same overall direction, but Canada’s sounder economy to provide an advantage that could mean Canadian stocks rally stronger and don’t fall any worse than their US counterparts.
USD vs. CAD
Per Basic Fundamental Analysis
Canada has one of the lowest debt/GDP ratios of any developed nation. Its banking and housing sectors are sound because they did not go through a housing/credit bubble and subprime crisis.
While Canada is heavily tied to the US (about 75% of its exports are US bound), employment, spending, and growth have been better there.
Per Basic Technical Analysis
As the above USDCAD chart shows, we have a decade-long downtrend that remains in effect until proven otherwise. The underlying fundamentals of countries change much more slowly than those of individual companies, so persistent long term trends - I mean years or decades - are not uncommon in forex markets.
In sum, while relative stock market performance of the two nations is unclear, both fundamental and technical analysis suggest that the CAD should continue to outperform the USD over the long haul. Should the Fed come out with yet another stimulus program or Canada continue on its slow but steady path of interest rate increases (unclear), then the trend should remain over the coming months as well.
For More On Canadian Stocks For Income And Currency Hedge
The following is a partial list of articles from 2009. While the recommended buy prices are outdated, and the energy trusts have converted to corporations, these companies remain excellent prospects for those seeking a great combination of high, relatively low risk income, and exposure to the CAD.
I’ve stopped writing about them over the past years because I didn’t believe that the rising prices were justified for long term investors, and continue to wait for markets to pull back before I add to my positions.
DISCLOSURE: The author has long positions in assorted US and Canadian stocks held primarily for long term income and currency diversification. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.