By Jeff Less
It’s not often that the markets offer currency moves that lead us to look at pre-Plaza exchange rates.
The 1985 agreement of representatives from Germany, France, Great Britain, Japan and the USA came about because the Super The strong dollar in the mid-1980s confounded the US trade deficit and kept foreign inflation stubbornly high.
Check out recent action in sterling (Figure 1). With the dollar continuing to bid relentlessly in 2022, the British pound is now as weak as it was post-Brexit. If things continue this way, levels may be challenged last seen in the pre-Plaza era.
Figure 1: USD to British Pound exchange rate
Sterling is not alone; the yen is also falling out of bed.
Although the yen is still a long way from its weakness in the 1970s – when 200-300 yen per dollar was the norm – the currency is back at levels rarely seen in the past quarter century. Right now, the yen’s decline is taking it higher to levels last seen when it depreciated in 2002, and there isn’t much room to recover from the 1998 weakness that followed the collapse of the Long-Term hedge fund Capital Management (LTCM) appeared.
Figure 2: Japanese Yen per USD
Meanwhile, the other big one – the euro – has reached parity with the US dollar. It just broke below its post-Brexit lows (Figure 3).
Figure 3: USD to Euro exchange rate
After the global financial crisis, these four major currencies – the dollar, sterling, euro and yen – each had CPI-based real effective exchange rates that were broadly balanced. As the dollar has strengthened over the years that has changed, with the EUR and JPY appearing on the cheap side on this metric.
Figure 4: Real effective exchange rate (CPI, 2010 = 100)
Granted, I’m writing this while Germany is in the process of bailing out Uniper, its big natural gas consumer, and while Japan is struggling to figure out if it should embrace nuclear power again. Unless the war between Russia and Ukraine ends suddenly, the energy crisis could plague those countries in the months and years to come.
Still, there’s a lot of sobriety in the MSCI EAFE index for developed market equities. Hard to believe, but the MSCI EAFE is currently in talks at its old highs of March 2000. Aside from dividends, it has been largely flat since then.
Figure 5: MSCI EAFE Index
The MSCI EAFE’s lost quarter century stands in sharp contrast to the action on the NASDAQ. In Figure 6, I placed it next to the “Stages of a Mania” picture that sometimes makes the rounds. I don’t know what the future will bring, but I think about it often.
Figure 6: “Stage of Mania” vs. NASDAQ Composite
If the coming years present a scenario in which US stocks must untangle a bull market that has gotten too far out of control, perhaps owning troubled foreign markets is the way to navigate it.
Here are three ideas for each of the currency approaches.
WisdomTree Japan Hedged Equity Fund (DXJ)
WisdomTree Europe Hedged Equity Fund (HEDJ)
WisdomTree International Hedged Quality Dividend Growth Fund (IHDG)
No currency hedging
WisdomTree Japan Small Cap Dividend Fund (DFJ)
WisdomTree Europe Quality Dividend Growth Fund (EUDG)
WisdomTree International Quality Dividend Growth Fund (IQDG)
Rules-based hedging (from 0% to 100% for each currency)
WisdomTree Dynamic Currency-Hedged International Equity Fund (DDWM)
WisdomTree Dynamic Currency-Hedged International Small Cap Equity Fund (DDLS)
WisdomTree International Multi-Factor Fund (DWMF)
Jeff Weniger, CFA, serves as WisdomTree’s Head of Equity Strategy. In his role, Weniger helps formulate the company’s equity market outlook by assessing macro and fundamental trends. Before joining WisdomTree, he was Director, Senior Strategist at BMO, where he worked in the Office of the CIO from 2006-2017. He was a member of the firm’s Asset Allocation Committee and co-managed the firm’s US and Canadian ETF model portfolios. In 2013, at the age of 32, Jeff was elected the youngest member of BMO’s Global Investment Forum, which brought together the firm’s top global strategists to formulate the firm’s official long-term outlook for investment trends and markets. Jeff has a BS in Finance from the University of Florida and an MBA from Notre Dame. He has been a CFA charterholder and a member of the CFA Society of Chicago since 2006. He has appeared in various financial publications including Barron’s and The Wall Street Journal and is a regular guest on Canada’s Business News Network (BNN) and Wharton Business Radio.
Editor’s note: The summary bullet points for this article were selected by Seeking Alpha editors.