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A PERSPECTIVE ON RECENT EVENTS — Q4, 2014
The Wrinkled, Crinkled, Wadded Dollar Bill
“I’m not bound, and I never will be, to a wrinkled, crinkled, wadded dollar bill.”
—Johnny Cash
• A surging U.S. dollar has led many to speculate about the effects to follow.
• While U.S. consumers of international goods and travel should benefit,
U.S. corporations may feel a negative impact from exports to international
markets.
• The dollar’s move, while swift in the short term, should continue longer term
due to diverging policies of global central banks.
JASON D. PRIDE, CFA
Director of Investment Strategy
• The strength of the U.S. dollar, and the weakness of the euro and yen,
should lead to a more balanced global economy.
• Finally, the dollar’s strength may entice the Fed to delay rate hikes and
should support international economies and equities.
CASEY C. CLARK, CFA
Research Associate
The Dollar’s Surge
The dollar is worth significantly more now than a few months ago. Relative to the
currencies of major trading partners, the dollar has surged nearly 6 percent since
summer. As a result, investors are beginning to worry about the related impact
on corporations, as well as the initial and downstream implications for the global
economy.
Bound by the Dollar?
While the U.S. economy is partly bound to the “crinkled” dollar bill, the effects
of a rising dollar are many, and in different proportions. An improving
dollar generally benefits U.S. consumers but negatively impacts U.S.
corporations. As the dollar rises, the price of imported goods and
international travel declines. This reduced pricing, in turn, puts competitive
pressure on the price of domestic goods, although such second-order effects
often take time to develop. One obvious example of this recently has been
the decline in oil prices, which has a meaningful impact on consumers,
although its decline stems from far more than just the dollar’s rise.
Corporations are more complicated, as they are both a buyer and a seller. As the dollar rises,
U.S. companies will find that internationally produced goods are more competitively priced,
resulting in a marginal shift in demand from domestic to international producers. In addition,
companies will experience a one-time negative adjustment as international earnings are
translated into dollars at the new, lower exchange rate. A partial offset is the declining price
of imported goods used in the production of U.S. goods. This effect, however, is rather small
compared to shifts in global demand.
The Bigger Picture — Not Really That Large of a Move
While the dollar’s surge seems sizeable relative to recent history, it does not appear
extraordinary when compared to historical currency shifts.
Research conducted by J.P. Morgan suggests that a 10 percent increase in the tradeweighted value of the U.S. dollar reduces export volumes by 4.4 percent and boosts import
volumes by 1.7 percent. With exports and imports at 13.5 percent and 16.7 percent of GDP,
respectively, the net effect on GDP would be a cumulative -0.9 percent drag on the U.S.
economy. Using this estimate, we conclude that the recent 6 percent currency move should
produce an economic drag of around -0.5 percent.
Monetary Policy and Unspoken Intentions
We believe recent global currency moves have occurred due to both regional economic
growth differentials and diverging monetary policies. The U.S. economy has meaningfully
outperformed its peers since the financial crisis in 2008/2009 due to aggressive monetary and
fiscal policies. The European and Japanese economies have recovered, but are struggling
amid a less consistent, but now strengthening, government response.
Currency moves are an intended but often unspoken outcome of monetary policy meant
to mitigate economic imbalances. If the U.S. net export/import mix declines, international
economies will concurrently realize a positive shift. As such, the recent strength of the U.S.
dollar will likely bring global economic growth into better alignment.
Implications: Low Rates Longer and International Aid
Global economic rebalancing would have two broad implications. First, the Federal Reserve
may have less incentive to raise rates as early as forecasted since a strengthening dollar
provides a modest headwind to U.S. economic growth — and inflation. So while rates will likely
still rise, the pace of increases may be more subdued than expected.
Second, a rebalancing global economy would mean improvement in Europe and Japan, two
of today’s weakest regions. Mario Draghi and the European Central Bank appear committed
to engineering and sustaining a European recovery, and we suspect more stimulative policies
will follow. Japan’s policymakers appear similarly committed to reinvigorating their economy.
While economic reform is no easy task, both regions are making significant strides.
Market Insights
Page 2
The Wrinkled, Crinkled, Wadded Dollar Bill
Disparate valuations between domestic and international markets overstate the current
divergence among European regional economic environments. We remain constructive
on international equity investments, knowing that we already own many valuable global
franchises at discounted valuations. While longer-term valuations are the primary determinant
of returns, should monetary policy and currency shifts work as anticipated, valuations may
provide near-term opportunities as well.
EXHIBIT 1: The U.S. Dollar’s Near-Term Surge
EXHIBIT 2: The Dollar’s Move Really Isn’t That Big...Yet
Exhibit 3: Rebalancing Needed: Disparate Purchasing
Manager Surveys
Exhibit 4: Disparate Valuations Reflect the Current
Environment but Also Provide Opportunity
Q4, 2014
Page 3
ECONOMIC AND MARKET VIEWPOINTS
• The global economy is now in the middle of an expansionary cycle, one that has
been slower than normal but will likely last longer.
• This stage of the economic cycle is typically accompanied by rising inflationary
pressures, declining monetary stimulus and slowing capital market gains.
• International economies still need monetary stimulus to sustain growth, while the
U.S. appears to be reaching a self-sustaining trajectory.
• Valuations for many assets now appear above normal, but are justifiable given
modest growth, low interest rates and low inflation.
• Given the risk of unexpected events (geopolitical, etc.) and the larger downside
from higher valuations, investors should be selective and build in cheap protection
to portfolios when available.
INVESTMENT STRATEGY: SELECTIVE RISK-TAKING
• Position portfolios to benefit from continued growth
°° Emphasize risk assets but be mindful of return/risk relationship
• Equities — Overweight, but favor cheaper options
°° U.S. high quality, secured options and international equities
• Fixed Income — De-emphasize interest rate risk
°° Favor short-duration/opportunistic strategies
• Enhance portfolios with alternative strategies
°° Absolute return and private equity strategies
Market Insights is intended to be an unconstrained review of matters of possible interest to Glenmede Trust Company clients
and friends and is not intended as personalized investment advice. Advice is provided in light of a client’s applicable
circumstances and may differ substantially from this presentation. Opinions or projections herein are based on information
available at the time of publication and may change thereafter. Information gathered from other sources is assumed to
be reliable, but accuracy is not guaranteed. Outcomes (including performance) may differ materially from expectations
herein due to various risks and uncertainties. Any reference to risk management or risk control does not imply that risk can
be eliminated. All investments have risk. Clients are encouraged to discuss the applicability of any matter discussed herein
with their Glenmede representative.
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