Cash Chronicles is coming to you this week from workcation mode in Southern California. The inflated real estate prices here, coupled with inflated stock prices have me looking abroad for returns over the next 5-10 years. As well as at a few short term opportunities given the growth we are seeing in certain US sectors.
Bargains in Foreign Markets
The relative strength of the US dollar since the financial crisis has hidden some great returns in local currency. Except for a few basket case exceptions like Turkey and Argentina, most major and emerging market currencies have gained on the dollar since last year. The notable exceptions in these cases are Brazil and Peru which have seen their currencies fall 8% and 5% respectively versus the dollar. It’s worth noting why in the overall picture of things and why these markets could become attractive very quickly within the coming year.
It starts with investment inflows and outflows. US investors can be quite alarmed at how quickly markets can move in emerging markets and this is due to the valuation effects being amplified by currency movements. Keep in mind that rich world investors, especially US investors, are the 800 lb. gorilla in the room, any movement they make into small capital markets can have massive effects as well as dizzying drops when they move out.
Take for example the recent case of Turkey. The Erdogan government dismissed its relatively orthodox head of the central bank in return for an official perceived as pliant to the whims of the president. Markets perceived this as a move towards looser monetary policy which would time interest rate drops around national elections to boost the incumbent’s popularity for reelection. In turn, this is viewed as pro-inflationary, which would depreciate the currency in relation to other currencies in addition to the domestic complications that high inflation causes.
The Turkish Lira dropped 7% on the announcement, and the local stock market dropped 10% but if you held a US based ETF that tracks the Turkish market like TUR, you saw your investment drop 17% overnight. Not every market goes through these kinds of swings often but it’s important to note that they do happen, especially when international investors are caught off guard by local news. In the case of Brazil, the poor handling of the Coronavirus outbreak, a weak market for its commodities (soya, ethanol, etc) and especially lower interest rates by the central bank have produced huge outflows from the local markets by international investors. 2017 saw rates as high as 14% which subsequently dropped to 2% until the central bank raised them 75 bps last month in a unanimous decision to stem the inflation spillover from the rise in commodity prices.
Fixed income capital had been flowing into Brazil for years to take advantage of the high rates but investors hit the exit button not long after rates started to fall, dropping the real from a little above 2 to a dollar to the 5.88 level seen today, a fall of over 60% in less than 4 years.
Yet the lower rates as well as the recovery from the worst post war recession in the country’s history, have produced a boom in the local index, the Bovespa, tripling your money in local terms since the market hit bottom in 2016. It has gone little noticed that the Bovespa has actually beaten the Nasdaq over this same period in terms of local currency.
The central bank moved up rates by 75bps in February when the market consensus was that they would raise by 50bps, the central bank means serious business. The conundrum going forward will be how to kill off the inflation produced by rising commodity prices without choking off the rally and the recovery from coronavirus that the country is experiencing at the moment. Currency movements will be strong drivers in economies like Brazil and Peru in the coming years where commodity swings produce a boom but also produce inflation locally. For its part, Peru has seen weakness in its currency recently due to its political turmoil and the ousting of its sitting President. Here again, emerging market politics can spill over into markets and surprise international investors. For now though, I will be keeping a close eye on the currency movements in these countries to be on the lookout for a breakout to the upside.
America First
With an eye towards opportunities overseas there are also markets continuing to gather pace here in the US which are directly benefitting from the Fed’s accommodative stance and the recent stimulus issued by the Biden administration.
Home prices in the US rose at the fastest rate rate in 15 years in January as rock bottom interest rates, limited supply and a relatively healthy job market for white collar workers has swelled demand. Home prices in January were up 11.2% year over year. The Fed for its part is dutifully buying up mortgage securities supporting the market to the tune of $2.2 trillion.
The SPDR S&P Homebuilders ETF (XHB) is a way to take advantage of the housing shortage through home construction companies as well as home furnishing companies such as Williams Sonoma. I prefer a more pure play on the construction sector through ETF’s like the iShares Home Construction ETF (ITB) which tends to purely track the home builders as opposed to companies that are home furnishing and construction related. XHB is up 22% year to date while ITB is up 21.6%.
With the Fed poised to keep rates low through 2023, the housing market looks to be at risk of another bubble. This bubble would not necessarily see the lax lending and irresponsibility of the last housing crisis but could put even more homes out of the reach of first time buyers and raise prices for renters as well. Fed officials do not seem that concerned about home prices as the higher purchase prices are being driven by borrowers with large down payments and good credit. It’s rather the lower rates that are driving the surge brought on by the Fed’s bond buying.
January saw 30 year fixed rates for mortgages fall to an average of 2.66% nationally in January. Even for those who were able to take out mortgages in the low 3% range in 2013 were now able to purchase new homes or refinance at sub-3% rates.
This is not an area I would look to be in beyond the next 2 years however. Rates have already jumped above 3% and builders will be rushing to meet the demand. This will hopefully bring some relief in terms of price rises and cool the market overall which can’t keep growing at this pace. My concern is that in the medium term rates will not be able to go much lower to support higher home prices and that a medium term softness may take shape as incomes need to rise to catch up with the jump in prices we have seen recently.
Consumer discretionary has been as hot or hotter than tech in the US markets but I feel the “revenge spending” has already been priced into returns over the past year. Instead I am looking for other sectors that lagged to “close the gap” towards the returns in these sectors by catching up, mainly energy, industrials and financials.
Just keep in mind that the next great investment is out there right now. It pays not to focus on past returns and what you may have missed out on but rather to look forward and make educated bets on where markets may move. Keeping an eye out could have you uncovering the next great investment and getting in early.
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