Investing with foreign currency effects

Three years ago, eleconomista.es published an article about how profitable it was to invest outside due to Foreign Currency Effects.

Those days the Euro was in the middle of a terrible bear market, which took it from 1.40 to 1.05 in a matter of a year.

When the article was published the EURUSD was quoting at 1.24 approximately, after which the euro depreciated even farther.

currency effect investing

From that point of view and if we only consider the currency effect, it was not a bad moment to buy United States stocks, since the next months the dollar rose almost 15%.

It would have been much better to bet against the euro when it was in its expansive phase, as it was the beginnings of 2014, when it was around 1.40.

In other words, here we can see that the best moments to invest are when the currency is overvalued or undervalued, so to speak.

One moment that was very good to invest in this regard was 2008 when the euro peaked at 1.60 against the dollar.

After that the euro has fallen significantly, just to recover the last year. The fact that it has been in a bear market the last years does not mean it will do so indefinitely, neither does guarantee the other way round.

Nowadays, after the euro has rebound from the bottom, it is near 1.25, which would be in a sort of intermediate point, something that always causes uncertainty.

From an investing point of view, is it a good moment to buy United States stocks again?

Eurgbp effect currency
there are some sort of long-term swings in the “currency effects”

Temporal horizon in the currency effect

Another very important variable is the timeframe of those investments.

If we buy an American fund with the intention of selling it 6 in six months time, moments like 2008 summer, December 2009 or May 2014 were good ones.

The problem is that when we invest it is when a long-term frame point of view and short-term swings should not concern us.

It would always be advisable to buy when the local currency is “expensive”, as it was the case of the euro from 2006 to 2008, or in the peaks that followed the years after.

Invest with currency effect in the Pound

Another typical case when we invest thinking of the currency effect is with the British Pound.

As we can see there in the long-term chart there is some sort of waves that last some years. In this case there are approximately 6 years between the peaks and the bottoms.

It would make sense to invest in British stocks in 1995 and 2009 and in European stocks in 2001 and 2015.

However, you may ask where the stock market is here, because nothing guarantees that it is worth doing a “foreign currency effect” investment if the stock market behaves much worse.

For example, for an American or British investor, it would have been a disaster to invest in the Greek market in 2010, but not so much for the currency effect, but for the stock market behaviour.

Foreign currency effect in the stock market

The Dow Jones beated the IBEX clearly

If we are going to look the effect in the stock market we may find surprises whether favourable or against.

For example, in the first case, from November 2014 to two years later after the EURUSD fell from 1.24 to 1.08.

Well, a Spanish investor in American stocks because thanks to the dollar he would have gained more than 10%.

However, he would think that the American stocks would have behaved worse than the Spanish ones. That is what the logic tells. You do not expect a stronger stock market when your currency is too strong. However that was what happened because Wall Street rose 12% whereas the IBEX fell 10 (from 2014 November, to beginning of 2017). After that, the Spanish who invested in Wall Street gained 20% whereas those who invested in Spain lost 10%.

The DAX has followed the “logic”, whatever it is in the stock market

When we have a look to the DAX30, another currency based on the Euro, we find that contrary to the IBEX35, we got a better return than that of Wall Street, in that case of 12%, which would cancel the “currency effect”.

usdjpy long-term

The king of the “currency effect”: the Yen

The most extreme case of the “currency effect” in the developed markets – I avoid things like the Argentinean peso or the Venezuelan Bolivar – is the yen, which next to the Swiss franc, is the strongest currency of the last 50 years.

The international investors, whether Americans or Spanish would think that it would be wise to have invested in the Jappanese stock market due to currency gains.

However, is we measure the return of the Nikkei the last 30 years we can notice that despite the “currency effect”, investing in Japan was not a good idea. This is especially true when we compare with the Dow Jones and the American markets.

Wall street currency effect

Nonetheless, when we look at a chart like that, perhaps we should notice that the Japanese stock market looks extremely undervalued in the long-term, specially compared to the West.

Time will tell though.

Conclusion

In many cases it is very difficult to get good trades due to this “currency effect”.

As we have seen many of the advantages get cancelled when we measure the stock market in the equation.

Therefore sometimes it is not worth to invest in foreign stock markets just because we think that their currency is “cheap”.

What we cannot disregard, is the fact that by investing outside we get some diversification, which is good in itself. You never know what may happen to your country.

Regarding day trading, it is something that should not worry us, because when we do so many trades every day, the currency effect should not be that important. Anyhow, it will matter when we want to withdraw our funds to convert them in our currency. If it is after one year of trading the exchange rate may have changed and some of our gains (or losses) may have disappeared.

In that case, the difficult thing is not withdrawing your profits, but to have profits in the first place.

Regards and good trading.

Original article: ¿Cuándo invertir con el efecto divisa?