Currency Performance And Stock Returns In 2016 Through Q3

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Includes: BZF, EIDO, EPU, EWJ, EWU, GXG, RSX
by: Daryl Montgomery

Summary

An investor's returns in a foreign market are determined by stock performance multiplied by currency performance.

Investors need to avoid markets where currency and stocks are moving in opposite directions, such as the UK and Japan.

The best choices are generally countries with strong appreciating stocks and currencies.

Returns on foreign stock investments shouldn't be analyzed in isolation. They need to be considered in relationship to currency movements. As a case in point, on October 4th, there was much press being given to a sharp rally in the FTSE 100 in the UK. While this was happening, the British pound was hitting a 31-year low. In reality, no money was being made by a U.S. dollar holder who had invested in UK stocks - the drop in the currency offset any gains taking place because of the equity rally (see chart below, which compares the FTSE 100, the British pound, FXB, and the return on the UK country ETF EWU). The lesson for investors is that when you invest in a foreign country's stock market, you would like to see both stock prices and the currency rallying.

British Pound Losing Value As FTSE 100 Rallies, Resulting in No Return for U.S. Investors

The best performing investable stock markets (those in which the average investor can participate in easily by purchasing ETFs) in the first three quarters of 2016 have been Brazil and Peru, up around 70%, Columbia, Indonesia and Russia, up around 30%, and Taiwan and Thailand, up around 25%. A more detailed description of global market performance from the beginning of January to the end of September can be found here.

Most of the countries that had top performing stock markets so far in 2016 have fairly obscure currencies that aren't actively traded: the Peruvian sol, the Columbian peso, the Indonesian rupiah, the Thai Baht, and the Taiwanese dollar. The Brazilian real (the world's top performing currency in 2009 and so far in 2016) and the Russian ruble are somewhat more prominent. Only the Brazilian real has an ETF (NYSEARCA:BZF) associated with it. When examining the 2016 currency performance in these countries, a wide range of returns took place (see chart below).

Currency Returns in Top Performing Stock Markets in 2016

As can be seen, although Brazil and Peru had almost identical returns in their country ETFs, the Brazilian real (the brown line) was up over 20% and contributed a great deal to what a U.S. investor earned. On the other hand, the Peruvian sol ( the blue line) was flat, so returns there were completely the result of the stock market rising. Of the second tier group, Columbia, Indonesia and Russia, Russia (the orange line), with the ruble up around 15%, had the biggest currency return. The Columbian peso (the red line) was up around 7% and the Indonesian rupiah was up around 6%. The Taiwanese dollar (the green line) and the Thai baht (the yellow line) were up around 5%. Note that all of these countries had currencies outperforming the dollar.

On the flip side, investors can look at what currencies are appreciating the fastest against the dollar to choose where they should buy stocks. Looking at the chart below of the top five performing currencies in 2016 shows they were: the Brazilian real, the Japanese yen, the Russian ruble, the Norwegian krone and the Columbian peso. We have already seen that three of these that are associated with top performing markets: the real, the ruble and the peso. Overall performance in Japan, though, is almost the same as in the U.S. It's the opposite case in the UK. The big rise in the currency is balanced by a drop in the stock market. In Norway though, the stock market is relatively flat and the currency accounts for almost 100% of the returns a dollar holder would get (exactly the opposite of Peru).

Top 5 Performing Currencies in the First 3 Quarters of 2016

For the first three quarters of 2016, investors who had holdings in Brazil and Peru (NYSEARCA:EPU) did the best, although the currency and stock components were quite different. The next best choices were Russia (NYSEARCA:RSX), Indonesia (NYSEARCA:EIDO) and Columbia (NYSEARCA:GXG). To determine when to get into a market watch both the major index and the performance of the currency. When both are heading up against the dollar, it's a good sign. Avoid markets like Japan (NYSEARCA:EWJ) and the UK (NYSEARCA:EWU) where one is going up and the other going down. Consider shorting markets where both are going down. Don't get seduced by the financial press highlighting stock prices going up but not paying as much attention to the currency going down. Those markets are not a good place to be.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.