What a fall.
We haven’t seen a decline on this scale since…well, since last year.
For most of the past year, the markets have focused on bond prices, bond yields, and stock prices.
But we’re not talking about that today. We’re not talking about the NASDAQ’s 2% drop last night. The one thing that most folks ignored over the past year is exchange rates.
And yet in any economy the value of a country’s currency relative to the value of another country’s currency is vitally important.
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So with the Aussie dollar falling off a cliff this month, what does it mean? And how can you profit from the Aussie dollar’s next move…?
The Aussie dollar has taken a beating from both sides.
On one side, it’s suffering from a weakness in the Aussie and Chinese economies. On the other side, it’s suffering from market expectations that the US Federal Reserve will begin raising interest rates.
If the Fed increases interest rates, that would cut the interest rate differential between the US dollar and the Aussie dollar. That differential is important. It plays a key role in the ‘carry trade’.
The carry trade is where big traders borrow in a low interest rate currency (for example, the US dollar or the Japanese yen) and reinvest the borrowed money in a higher interest rate currency, such as the Aussie dollar.
Higher US interest rates therefore make it less attractive to borrow US dollars to invest in the Aussie market.
Hence, the Aussie dollar has collapsed, as you can see on the right of this chart:
The Aussie has fallen more than 5% against the US dollar since the start of the month.
Just the way the Fed wants it?
The question is: Will the Aussie keep falling?
This is one of those times when it really could go either way. But it’s not so much about what the currency will do itself. The currency merely reflects the economy.
It comes down to whether the Aussie and Chinese economies will worsen, and whether the US Federal Reserve will carry through with its claim that it will raise interest rates.
If you think it’s bleak times ahead for Australia and China, and that the Fed will raise rates, then it’s a good bet that the Aussie dollar will fall.
Could it collapse below the low 80 cent level last seen in 2010? Or what about the low 60 cent level last seen in 2008 and 2009? It’s not impossible, but is it probable?
Certainly, based on last night’s action in the US, the market doesn’t seem to think the Fed is about to jump in with more stimulus. If it did you wouldn’t have seen stocks take a bath to the tune of 1.6% on the S&P 500 index.
But in our view, this is all just part of the Fed’s game.
In general, there are two views on what the Fed is up to. Neither of them is right. One group says that the Fed is all about creating asset price bubbles and that it will pump up prices like there’s no tomorrow.
The other group says that the Fed doesn’t need to do anything else because the economy is recovering under its own steam.
The reality is different. The Fed’s real game is to engineer a gradual advance in stock prices. The Fed wants to take the role of ‘director-in-chief’ of the markets.
It wants to guide the market gradually higher, say, by 10–15% per year. That will be low enough so that investors don’t think that stocks are in a bubble, but high enough for investors to believe that the economy is growing.
At the moment the S&P 500 index is up 6.8% for the year. Annualised, that’s a 9.1% gain. But that’s OK. Remember that the markets always like to look forward to the famous ‘Santa Claus’ rally during December. That could easily add an extra percentage point or two to the current annualised rate.
More than just dollars and cents
If we’re right about the Fed’s game playing, it will have an important impact on the Aussie dollar. That’s why we’re not giving up on stocks yet…despite the clamour of folks telling us we’ve gotten it wrong.
If the Fed decides to jump back in with more stimulus, or talks up the idea of more stimulus, or even just reassures the market that interest rates are staying low, it won’t be long before the Aussie dollar reverses its tack.
That doesn’t mean you’ll see the US$1.20 that many mainstream folks predicted not so long ago. But it could see the Aussie dollar remain comfortably above 90 cents, and even back towards par with the US dollar.
But it really does all depend on whether we’re right about the Fed’s intentions.
However, all that said, just remember one thing. Some stocks will rise and other stocks will fall regardless of what the Fed does. The stock market isn’t a single organism that floats or sinks en masse.
If you step back from the typical stocks in most portfolios (boring blue-chip growth stocks) and look at the stocks most investors ignore, it’s possible to find opportunities that can perform in any market.
Surprisingly, given the current environment, one of the best examples of these stocks can be in commodities such as oil. If an oil explorer finds oil or increases its reserves there’s no doubt the company’s share price will rise.
You see that happen time and again. The most recent example is Carnarvon Petroleum [ASX:CVN]. Its drilling partner, US energy giant Apache Corp [NYSE:APA], discovered an oil field off Western Australia. Carnarvon’s shares soared 200% the next day.
That was just a few weeks ago, in this current volatile and risky market.
Look, that doesn’t mean every high-risk stock will soar to the heavens. But it just goes to prove that regardless of what happens in the broader economy, or even to the Aussie dollar, there are always stock opportunities somewhere.
The trick is know where and when to find them!
Cheers,
Kris+
The post The Aussie Dollar is Important, but it’s Not Everything… appeared first on Stock Market News, Finance and Investments | Money Morning Australia.
