A quick glance at the U.S. Dollar (DXY) Index shows that, since
the start of the year, the dollar is fractionally higher. But
this index, which is an often-cited proxy for relative dollar
strength, has its limitations. It is a weighted index of the
dollar's value against six foreign currencies: the euro,
yen, pound, Canadian dollar, Swedish krona, and Swiss franc.
The euro alone accounts for over half of the weighting. Because
of the narrow composition of the index, it can provide an
incomplete picture of how the dollar is faring against excluded
currencies, including those of some important investment
destinations for U.S. investors.
Even for purposes of analyzing foreign developed market
equity returns for dollar-based investors, the DXY index can
provide a misleading reference point. As one would suspect,
this should not be especially true for returns from within
the Eurozone, given the euro's high weighting in the
index. In fact, equities within the Eurozone are higher by
4.8 percent year-to-date in dollars and 5.0 percent in euros.
For all of 2011, Eurozone equities lost 20.1 percent in
dollars and 17.6 percent in euros. This differential is a
reflection of the euro's 3.1 percent decline versus the
dollar and not dissimilar to the 1.5 percent rise in the DXY.
The same similarity of returns can be seen in Japan
year-to-date, where the Nikkei index is higher by 3.7 percent
in yen and 3.5 percent in dollars, as the yen/dollar
relationship is virtually unchanged. However, in 2011, the
DXY would not have suggested the wide disparity in relative
returns for dollar- and yen-based investors, given the
yen's low weighting in the index. Calculated in yen, the
Nikkei lost 17.3 percent, while in dollars it declined only
Not surprisingly, given the absence of any emerging market
currencies in the DXY, the disparity of returns accounted for
by currency movements can be even more pronounced with
emerging market investments. Year-to-date, the MSCI Emerging
Markets index is higher by 6.0 percent in local currencies,
but 8.6 percent in dollars, despite the DXY being virtually
unchanged. In 2011, when the DXY rose 1.5 percent, the
Emerging Markets index lost 20.4 percent in dollars, but just
14.9 percent in local currency terms.
This kind of wide differential is especially pronounced in
returns so far this year, but mostly to the benefit of U.S.
investors, as the dollar has fallen sharply against some
emerging market currencies. For example, in Brazil local
currency equity returns are higher by 9.8 percent, while in
dollars these returns jump to 16.0 percent. In Chile, the
differential is 2.4 percent versus 8.0. In Mexico, it is 0.8
versus 6.6. The same disparity is evident in Asia although it
is somewhat less pronounced, with the exception of India.
There, the respective returns are 8.3 versus 14.5 percent. In
Korea it is 6.8 versus 9.1.
It is one thing to be aware that relative currency strength
in any particular country may differ significantly from an
index. It is something else again to understand what is
In the case of emerging markets, the first thing of note is
how sharp a turnaround this year's currency strength
represents from the second half trend of last year. In
Brazil, the real weakened by almost 20 percent against the
dollar over the final two quarters of 2011, but has
strengthened almost uninterruptedly since the start of the
year for a six percent gain.The story in Chile is the same.
After falling by 11 percent in last year's second half,
the peso began a rally at the start of the year that has seen
it rise by five percent in just three weeks. The same is true
in Mexico, India, and Korea.
These trend reversals come as many emerging countries are
shifting toward easier monetary policies in an effort to
stimulate growth, having achieved some success in their fight
against inflation. Expected economic growth differentials
with developed markets in 2012 are beginning to attract
investment flows, especially as concerns over the Eurozone
have eased in the past few weeks, and given the abundance of
liquidity in the developed markets. The Conference Board
forecasts economic growth in advanced countries of just 1.3
percent in 2012, compared to 5.1 percent in emerging
countries. For all of 2011, emerging market equity funds saw
outflows totaling five percent of assets. Yet for the first
three weeks of this year they have seen inflows totaling 0.7
percent of assets. Regional Latin America funds experienced
outflows of 12 percent of assets in 2011, but have seen that
pace fall to just 0.2 percent so far this year. Asia Ex-Japan
funds have seen a similar turnaround, going from outflows of
seven percent in 2011 to inflows of 0.4 this year. In
addition, interest rate differentials versus developed
markets remain attractive. The overnight rate in Brazil is
10.5 percent, in Chile 5.0, Mexico 4.5, in South Korea the
seven day repo rate is 3.25 percent, and in India the repo
rate is 8.5 percent. In contrast, in the U.S. it is 0.25, in
the Eurozone it is 1.0 percent, in the U.K it is 0.5, and in
Japan 0.1 percent.
Inexpensive valuation metrics suggest that emerging market
equities may have further room to run. But rising risk
appetites are fragile and easily derailed. A lot has to go
well for recent gains to be extended. U.S. economic data
needs to continue its recent improvement, Europe needs to
continue to make gains in solving its debt crisis, and China
needs to avoid a hard landing. The news on all three fronts
has been encouraging of late. Let's see if it
The views expressed are as of the date given, may change as
market or other conditions change, and may differ from views
expressed by other Ameriprise Financial associates or
affiliates. Actual investments or investment decisions made by
Ameriprise Financial and its affiliates, whether for its own
account or on behalf of clients, will not necessarily reflect
the views expressed. This information is not intended to
provide investment advice and does not account for individual
investor circumstances. Investment decisions should always be
made based on an investor's specific financial needs,
objectives, goals, time horizon, and risk tolerance.
The U.S. Dollar Index (DXY) measures the dollar's value
against a trade-weighted basket of six major currencies.
The Nikkei index is a price-weighted average of 225 stocks of
the first section of the Tokyo Stock Exchange.
Morgan Stanley Capital International Emerging Markets index,
an unmanaged market capitalization-weighted index, is
compiled from a composite of securities markets of 26
emerging market countries.
Investments which concentrate in geographic regions may
expose an investor to greater volatility: for example,
currency fluctuations, differences in security regulation,
accounting standards, foreign taxation regulations and
political risks. These risks may be enhanced in emerging
It is not possible to invest directly in an index.
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