Contrarian Investing

Quiz!

What does a dollar far above average do to future emerging markets returns?

1. It hurts emerging markets returns.
2. It helps emerging markets returns.
3. There is no correlation between a very high dollar and future emerging markets returns.

Does a High Dollar Lead to Poor Emerging Markets Returns?

I’ve seen articles explain how a high dollar hurts emerging market (EM) economies. With the dollar recently reaching the highest level since late 2002, some articles gave concerning messages related to emerging markets investments.

Historical evidence for the opposite: The history of EM investments shows opposite results. When the dollar reaches high levels, future returns of EM tend to be stronger than when the dollar is low. For example, the recent time we had such a high dollar (2002) was around the beginning of phenomenal 5 years for diversified EM stocks.

Explanations: Once the dollar is at unusually high levels, the negative effect of the dollar is priced into EM stocks, with lowered valuations (price/book and price/earnings). Given that the dollar is cyclical, at some point we got a reversal, with a declining dollar. Some of the logic of the articles can be used to explain the benefits of the declining dollar, helping EM stocks.

Caveats: This quick read shows counter evidence + logic to many articles you may read in some prominent sources. There are still big unknowns. The dollar may have just peaked, or it may go up further. The goal of this article isn’t finding the exact peak, but looking at odds for further increases vs. decreases. When a cyclical measure is above average, you would expect higher odds for the measure to go lower than higher.

Quiz Answer:

What does a dollar far above average do to future emerging markets returns?

1. It hurts emerging markets returns.
2. It helps emerging markets returns. [The Correct Answer, but read explanation]
3. There is no correlation between a very high dollar and future emerging markets returns.

Explanation: A rising dollar lowers the value of emerging markets (EM) returns as measured in dollars. So, the past EM returns leading to the dollar highs are hurt. Future emerging markets returns depend on the future movement of the dollar. From a level above average, the dollar is more likely to decline in the future. That would lead to above average returns. A caveat is that this simply reflects odds, not guarantees or specific timing.