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the "wealth effect ' and its interaction with Inflation , interest rates and household savings rate

In earlier posts i had outlined how by extracting excess return percentages it may be possible to estimate future price movements of Japan  focused etfs .

In this post i would like to write about the impact of a strong exchange rate working through the wealth effect (and its  interaction with inflation, interest rates  and savings rate  rate ) can have a profound impact  On stock index Etf price movements .

When countries exchange rate is strong (as measured by its relative value against its major trading partners ) this creates a positive feeling of enhanced financial security  as households feel  more financially secure as their currency has "enhanced buying power" on the international stage.

This "wealth effect " would then likely feed through into portfolio investments leading to an increase in  stock index of that country.

However i believe the rate of portfolio inflow is determined broadly by 3 factors  namely a) rate of inflation b) interest rates and c) household savings . To expand on this

a) high inflation is likely to slow the rate of portfolio inflows amongst domestic economic agents since it reduces the buying of the currency on a national level. Under such a  scenario the "wealth effect from a strong currency is largely negated as individuals seek  to keep liquid cash to make bulk purchases to "hedge against future price increases  -this behavior would slow the rate of inflow into shares

b) there is negative correlation between high "real" interest rates i.e risk free rate of return and rate of portfolio inflows i.e. The higher the risk free rate of return the lower   rate of growth in portfolio inflows and vice versa _this scenario is likely playing itself out in the Brazilian stock markets which although  currently having a strong currencies has a low "real" rates of interest " thereby empowering economic agents to invest in shares  which  lead to huge gains in the   stock and currency markets this past year..

c) household savings rate i.e income available  after monthly budget  expenditure is likely to impact on portfolio inflows. Changes in mortgage rates, credit card payments and population demographics are some of the main  components in household savings rates and a  study of these figures can prove rewarding in determining the rate of inflow in shares from households when the "wealth effect is felt .

Based on this analysis the question may be asked "which Single country Etfs are currently benefiting from the wealth effects and are likely to rise in the very near future".

In my research of the Australian, Brazilian , Japanese and the Indian stock Indices using currency/country relative  excess returns percentages the clear 'winner ' currently is Japan  followed by Brazil, Australia with India lagging 

specifically my research has shown that 

a) the Japanese yen has strengthened and has benefited from bouts of risk  adversity and b)unwinding carry trades leading  to the "wealth effect "amongst Japanese householders

this is further reinforced by the fact that

a)inflation is benign
b real interest rates are negligible
c) household savings rate have  increased substantially since the 1990s as consumers have repaired their respective private  balance sheets. There is now plenty of capital on the sidelines which is likely to find its way in the Japanese  stock market  in the very near future giving boost to stock prices .

Brazil and Australia on the other hand are both benefiting from continued demand for commodities as well as their close ties with China (indeed these markets are increasingly being viewed as  credible  proxies to the Chinese stock market ).

The Australian  currency is benefiting from the interest rate differential  it enjoys with other developed countries making  income earning in Aussie dollars  a pleasurable experience!!!-some of this wealth is likely to find its way into the stock market.

Brazil on the other hand is benefiting from continued demand for its products as well as high gross interest rates  making management  and sterilization of inflows  a difficult task for policy makers!!!

As to which country from my list is currently not benefiting from "wealth effects " I would have to say India .

A combination of a weakening exchange rate, rampant inflation , falling household savings rates and negative "real" rates of return combine to make the average Indian  feel financially poorer  and keep him away  from stock market Investing over the next few months .  

In  later posts i hope to  outline  a simple trading method that may be implemented  to enable  investors seeking to benefit from the translation by economic agents of the "wealth effect" into portfolio inflows  into  their national stock markets.

Disclosure: No positions held