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