The Dividend Cafe - Their Weakness is Not our Strength

Episode Date: September 9, 2022

I first want to thank everyone for the extremely positive feedback last week on the somewhat unique Dividend Cafe juxtaposing USC football and markets. It was fun to write and, at least for some of you, appears to have been fun to read. But for those who prefer the serious stuff, we are back to normal this week, and I think it is time I cover a topic that comes up a lot anecdotally, but I don’t think has ever received headline treatment in the Dividend Cafe. And yet, it is one of the single most important topics in the field of economics and finance … I refer to currencies, the U.S. dollar in particular, but really the overall global dynamics of currency and what it all means to investors. Currency ramifications impact all investors all the time, yet we rarely contemplate why or how. Today I want to play around a bit with some aspects of this critical topic in the present reality. Jump on into the Dividend Cafe … Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Well, hello and welcome to another episode of the Dividend Cafe. I am recording, having just arrived in Washington, D.C. on a Friday afternoon where I'll be speaking at a debate event tomorrow, Saturday. But I'm going to clue you in on a secret. I wasn't going to say anything, but I actually recorded Dividend Cafe earlier this morning before I left L.A. and we had some technical issues. And so now I'm re-recording. And for those of you who have ever done this kind of thing, you may know that recording something twice

is never necessarily your favorite thing to do. And the reason is that you feel like when you go to the driving range, you left all your good shots there. And then the second time around, it's not going to be as good. I'm really determined to not let that happen now. I luckily had a long flight, got a lot of

work done, so I think I still have the energy necessary to do this right. But if for any reason this podcast bombs, I just want to say that the one I recorded first was way better. And if you really like this, then it's because I improved it from this morning. You get to pick. Okay, I want to talk to you today about the subject of currency, of basically the dollar. Now, of course, if we weren't talking to American investors, then the dollar would not be their domestic currency. But for the most part, that's who I assume is listening. And I think there's a kind of embedded message in the value of a country's currency, that message that transcends just the mere economic reality or ramifications of that currency's value itself. about economic growth, about interest rates, about governmental credibility, about central bank credibility, about trading, about the attractiveness of the region. So the strength of a currency is important. But the first thing I have to kind of dismiss is the difference between strength of a

currency the way we're talking about today, which is one country's currency relative to other country currencies, and the purchasing power of a currency, which is how most people would naturally think about it. Do you feel like the dollar is strong? Is it allowing you to buy more things or less things? If prices are going higher and your single unit of currency, your dollar, is buying you less things, then that feels bad, right? That is entirely true, but it speaks to a different category of what we're getting at. And in fact, sort of begs the question, because

we are in a violent tear higher for the U.S. dollar right now, when for about 18 months now, one of the predominant things in the economy has been the increase in the consumer price index. So it has for some time confounded people wondering why is the dollar strengthening as its purchasing power is declining? And my point all along has been not, well, is there some sort of contradiction here, but is there an answer here that the strengthening dollar was telling you the rising prices were a byproduct of supply side issues, the inability to have enough goods and services to meet demand coming out of a lockdown. There's a lot of other complexities around it. And I promised myself I wasn't going to burden

you with yet another talk on the very important subject of inflation deflation. That subject is as important right now as ever, but it's just not what I'm here to talk about today. So what I am referring to when we talk about a rising dollar is not better purchasing power because we don't have that at this moment. Over the last 12 months, people can buy less things with their dollar. And yet, against the DXY dollar index, which I'm going to explain what that is in a moment, the dollar is up 17.8%. Now that was as of four o'clock this morning. And if something moved a few pennies in the course of this fight, then be that as it may. What is the DXY? It's a way to measure the dollar's value against other currencies. And it was set up in 1974 using six major global currency counterparts. Today, it's still the

same six. Now, the euro didn't exist then. So when the euro came on in 1999, they replaced Germany, Italy, France with the kind of equal, it was a pro rata wading into the euro. And then you have the yen, you have the Swiss franc, you have the Swedish krona, the Canadian dollar. And forgive me if I missed one, I believe I just covered all the basics. I think it's a fine way on apples to apples basis with a methodology, a measurement that doesn't change. So the problem with the methodology doesn't change, the circumstances may change, and this measurement isn't going to account for it. The benefit is it's apples to apples, it stayed level in how it's being looked at. And relative to these other currencies,

the dollar is up substantially. It has been for some time, but just on a 12-month basis, it's up nearly 20%. Now, in 1998, the Fed came around and said, you know, one of the more important elements of what a currency is worth is what you're buying with it when you're transacting with a foreign country. In fact, you never really know, let alone does it matter, what the dollar is worth relative to the euro until you buy something with it. And so it's when the exchange takes place. Therefore, the amount of exchanges that take place speak to the relevance of the dollar's value versus the Mexican peso, the Japanese yen, or whatever the currency may be. peso, the Japanese yen, or whatever the currency may be. So they created an index that trade-weighted the dollar to the other currencies. So just to be very simple, if one country is 1% of our imports and exports, and another country was 20%, then that country would be 20 times in the index what the other one was. So I'm trying to make it as simple as I can, but it's just another way of looking at how the dollar is doing against other currencies,

but it's measuring them based on how much we trade, what percentage of trade that country represents with us in the combined imports and exports that we do with one another. By that measurement, the dollar is up about 11% on the year. So the first, the DXY doesn't take into account Mexico and China, a lot of other emerging countries that are very important. It isn't trade weighted, but it has a higher allocation to yen and euro. And so that's why the dollar has done even better against that basket versus the trade weighted. But the point directionally is the same. The dollar is essentially up around the world. And this has created a lot of questioning. And then it's led to the number of assertions.

Well, the Fed is tightening monetary policy. So interest rates are higher. People like the dollar when you can go buy treasuries or deposit accounts and get 3% versus when you were getting zero. Well, that's certainly true, but there is a problem with that theory. Everyone else is pretty much tightening also. Now, Japan's not. So that would explain why the yen is declining and the dollar's rising against it. The euro, they're tightening in Europe, but not as much as the dollar. So that absolutely, those interest rate differentials are a factor in the differing values between dollar and yen,

dollar and euro. But there's plenty of other countries where it's not. And even if interest rate differentials are a larger factor right now than they are maybe at other points in time, which I'm not convinced of, I still don't want us to ever assume that there's a singular factor when there's a permanent multiplicity of factors. The relative geopolitical stability, the credibility of the government, the assumptions about the central bank stability,

the attractiveness of trading with a given country, the way in which that country uses their currency to advantage their own trade, all these types of things. Now, some may say, first of all, why are we even talking about this? Isn't it a great thing? The dollar going higher is a good thing. And I kind of start in that premise before I'm allowed to nuance it because I'm an American and I would like a strong American dollar, all things being equal. So what is the problem to begin with? Well, first of all, the advantages to a strong dollar should be that it speaks to a stability. And I'm not convinced it does in our case. So even if you get a thing you like for the wrong reason, that's a reason to be cautious. But second

of all, for an American-based investor, buying international assets, a strong dollar can be a problem. You're buying stocks or bonds in other countries, and their currency that you're going to buy into is weakening versus the currency you came out of that limits that that pushes downward pressure on the value of your investment. That has helped us at the Bonson Group this year, relatively speaking, because we have basically no allocation to Europe or or Japan. and those currencies have weakened so much, most US-based global investors have a higher allocation to Europe and Japan and so have taken on more of this currency hit. Now, we have an allocation to emerging markets in our growth enhancement portfolio and a different emerging market strategy in our income enhancement portfolio. And so the weakening

currencies there relative to a strengthening dollar puts downward pressure on that. It also represents an advantage at the point at which that reverses. Mean reversion would then represent an opportunity in that sense. But my point is, apart from investors, there is a negative in the economic realm to a strengthening dollar, and that is for exporters, right? We are a heavy importing country, and it's a great thing to have a strong dollar when you're importing. But when you're exporting, you are losing competitiveness in the marketplace because your goods are more expensive and they're going into a foreign territory, a foreign domicile. And you're losing competitiveness there because it's being done more expensively as the currency is higher. Utilities is a great example of why that just wouldn't matter for the American economy because we're not, our American utilities companies aren't doing business overseas. So the dollar strengthening doesn't hurt them.

Well, lo and behold, utilities have done quite well this year. Thank you very much. Technology, 51.8% of the technology sector's revenue comes out of the United States. American tech companies do a little over half of their revenue outside the U.S., so a strong dollar hurts them. Materials is, I think, the second, is the sector with the second most revenue exposure overseas. So you end up getting a very different treatment of how the dollar does affect certain sectors and companies based on their level of imports and exports. But all things being equal, we import more than we

export. And a strengthening dollar, in theory, for the right reasons, is a reflection of a strong economy or a strong desire to do business in a country or a strong level of trust and credibility in a particular economic landscape. And so in the strong dollar era of the 80s and the strong dollar era of the 90s, even where on a micro basis it could be hurting certain companies, the overall landscape for markets was so strong that they were overcoming it. You would rather be gaining new markets, new customers, even if you're losing a little bit of relative competitiveness

or pricing power. And that's been the case in the past. That's not the case right now. The dollar is not strengthening because everything's going so well and people are bidding up the dollar. It's strengthening for the wrong reasons. And this is why the sort of verbiage, the grammar, if you will, matters. It's not technicality. It's not being cute. And of course, they all equal the same thing. When you say three plus six equals nine or six plus three equals nine, you have said the same thing, but the

causation is different in when I say the euro and yen have weakened. Well, by definition, if we're talking about the dollar, the dollar is a higher price relative to yen and euro, and the yen and euro have a lower price relative to dollar. It's a six plus three, three plus six thing. It's the same, but the reasons are different. And I would argue that the reasons for that exchange alteration this year is more to do with the weakness of the other currencies and the strength of the dollar. What I would love to see is a strong dollar because we have reestablished monetary credibility. We have a certain sense of expected fiscal stability. God forbid, maybe we even have a balanced budget,

if anyone knows what that is. The idea of rule of law, the idea of, now we most certainly are a very attractive place to want to do business relative to most of the world. This is China's big problem in trying to establish a currency credibility. They've done a really good job relative to 20 years ago at making the world want to transact in their currency, but they can't get to where they want to go because it's still not considered a particularly attractive place to do business. That's what they're seeking to remedy. I've written dividend cafes about that in the past. So the bottom line point I would make is that the way the dollar works as a

currency relative to others is a byproduct of things that they're doing with our currency policymakers on the monetary and fiscal side, and a byproduct of what might be taking place in other countries. And I think that we're dealing in a situation right now where the strong dollar is happening for less than ideal reasons. It is not repeatable or sustainable, in my opinion. There will be a point at which it reverts to the mean. And at the same time, it is more selective in how it helps and hurts. It is not as much of a factor, as I mentioned, utilities. It's more of a factor in technology, et cetera. There's other weeds I could go into about why certain Asian ex-Japan currencies are doing certain things right now, why countries choosing to weaponize their currency invites a lot of

complexity and undermines the stability I'm talking about. All the stuff that Russia did with Ukraine adds a lot of complexity to currency values. And then all the sanctions that the West put on Russia have added to that questioning. So I'm going to go ahead and leave it there. that questioning. So I'm going to go ahead and leave it there. Please reach out with any questions you may have. I will be kind of going through on the edges some other currency related things throughout DC today and future Dividend Cafes going forward. But I hope you will at least right now feel like you got a little bit of a primer on how currencies work and why they're relevant to the current discussion. Why with recession talk and with the state of inflation concerns and whatnot, the dollar is doing what it's doing. And more importantly, where investors are unwise to try to exploit it or bank on it, that there isn't a particular repeatable sustainable trend in a

currency moving higher. These things are very unpredictable because we have a lot of unpredictability and a lot of instability in the global policymaking arena here in the States and in Europe, Japan, China, whatever the case may be. I hope it's helpful. I hope you've learned. I'm open to questions. Rate Dividend Cafe, subscribe, share it. All the things I say every week that I'm sick of saying, but have to. Thank you for listening to and watching the Dividend Cafe. with Hightower Securities LLC, member FINRA and SIPC, with Hightower Advisors LLC, a registered investment advisor with the SEC. Securities are offered through Hightower Securities LLC. Advisory services are offered through Hightower Advisors LLC. This is not an offer to buy or sell securities. No investment process is free of risk. There is no guarantee that the investment process or investment opportunities referenced herein will be profitable. Past performance is not indicative

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