INVESTMENT STRATEGIES FOR TORTOISES CURRENCIES. Robert G. Kahl, CFA, CPA, MBA

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1 INVESTMENT STRATEGIES FOR TORTOISES CURRENCIES Robert G. Kahl, CFA, CPA, MBA

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3 WHAT DETERMINES CURRENCY MOVEMENTS? Balance of Payments Foreign Currency Reserves Purchasing Power Parity

4 BALANCE OF PAYMENTS Balance of Payments = Current account + capital account Current account measures the net change in traded goods, services and transfer payments Capital account measures net purchases/sales of assets such as stocks, bonds, land, and other financial assets When a country has a balance of payments deficit, it must use its currency reserves to cover the deficit. Conversely, if a country has a balance of payments surplus, it will accumulate more foreign currency reserves.

5 FOREIGN CURRENCY RESERVES Are held by central banks and sovereign agencies to settle international transactions Consist of gold, other currencies, deposits, or financial securities denominated in major currencies Currencies are often devalued when foreign currency reserves run low

6 PURCHASING POWER PARITY THEOREM Identical goods will have the same price in different markets absent transaction costs and/or trade barriers when prices are expressed in the same currency. Currency exchange rates should have a tendency to move toward a rate representing purchasing power parity among countries an equilibrium state. Undervalued currencies based upon purchasing power parity estimates are Russia, Brazil, China, Mexico Currencies may remain undervalued for an extended period of time

7 DYNAMICS OF CURRENCY VOLATILITY IN EMERGING ECONOMIES Foreign governments and corporations borrow in US dollars rather than local currency Countries may depend heavily on a few commodities They may depend on necessary imported goods denominated in foreign currencies Changes in foreign capital flows may impact the currency rate (Asian financial crisis of ). Nature of capital flows has an impact Marketable securities, real estate, or manufacturing plants?

8 THE IMPACT OF CURRENCY DEVALUATION ON FINANCIAL MARKETS Currency devaluations are often accompanied by higher interest rates as capital leaves the country Investors may move money from banks and fixed income securities to common stocks because they represent a superior inflation hedge. Investors in common stocks of countries that experience currency devaluations generally lose purchasing power compared to investors that have capital denominated in a stable currency.

9 SELECTED CURRENCY DEVALUATIONS AND RELATED STOCK MARKETS Country Period Duration (Months) Currency Sweden 8/15/1992-3/15/ Krona Index OMX Stockholm 30 Index Currency % Change vs. US$ Index % Change in Local Currency Total Gain/(Loss) in US$ -31.7% 26.7% -13.4% United Kingdom 8/15/1992-2/15/ Pound London FTSE % 20.8% -5.8% Mexico 10/15/1994-9/2/ Peso Mexico IPC -66.5% 14.5% -61.6% Indonesia 7/1/1997-7/7/ Rupiah Jakarta Composite Index -83.7% -35.4% -89.4% Russia 1/13/1998-8/31/ Ruble Moscow RTS Index -59.5% -80.8% -92.2% Brazil 1/12/1999-3/3/ Real Brazil IBOVESPA -44.2% 54.7% -13.7% Argentina 1/3/2002-6/26/ Peso Merval Index -74.0% -2.5% -74.7% Japan 9/27/2012-6/29/ Yen Nikkei % 126.1% 42.2%

10 THE RESERVE STATUS OF THE US$ IS IN JEOPARDY US current account deficit $128.2 billion for 4Q/2017. Has been running over $100B per quarter on regular basis. US net international investment position as of 4Q/2017 was (negative) US$ trillion. It was about $ -2.0 trillion as recently as International monetary developments Concerns about credit quality of US Treasury debt G20 replaced the G8 in Countries represent 85% of global GDP, 75% of global trade, 67% of global population.

11 THE RESERVE STATUS OF THE US$ IS IN JEOPARDY (CONTINUED) International monetary developments (continued) Alternative organizations created that are not controlled by the US BRICS Development Bank w $100B capital BRICS Contingency Fund w $100B capital Asian Infrastructure Investment Bank (AIIB) w $50B initially and eventually $100B Shanghai Cooperation Organization (SCO) World currency? SDR promoted by some Gold promoted by others

12 CONCLUSION Although US investors naturally have a US currency bias, there are diversification benefits from the inclusion of securities that are denominated in foreign currencies in an investment portfolio.

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