How a Strong Euro Impacts Stocks

Transcript

Ken Fisher:

The euro has been strong this year. The dollar has been weak. Pound sterling's been strong, but not as strong as the euro. Swiss francs have been strong in between. Aussie dollar also a little bit like the pound sterling Britain.

What does that tell you? It tells you very little beyond what I just told you.

But I'll say conventional wisdom has people freaking out whether a currency is strong or weak. When the currency is strong, they think that's going to inhibit exports. They think it might cause economic weakness in GDP. When it's weak, the currency, they tend to think it's going to cause inflation. They tend to think that it's going to be, on the other hand, offsetting that, good for economic growth. A lot of people think that about the US dollar right now.

And the fact of the matter is there's a simple test to see if any of that's true. And while there's a lot of babble and has been all of my adult life, and long before I was an adult, long before I was born, on this topic, there's a simple process to know it's nonsense. Again, we have a very long history of currency pricing. We have a very long history of inflation, not just in America, but in demonstrable countries with fairly similar inflation indexes around the world. We have a long history of stock market returns, and there's a very simple statistical concept called correlations, which you could look up online and learn how to run yourself. It's not that tough to do. Data's online. You could learn how to do the technique online.

But when you run a correlation between one thing and another, if they move over the time period that you're measuring, perfectly similarly, the correlation comes out to be 1.0. If they move exactly in opposite, one goes up, the other goes down at the same time and consistently perfectly so, then they have a correlation of -1.0. And if they move perfectly in random to each other, the correlation becomes 0.0.

Now this test does not prove causality, but it will prove non-causality. That is, if one thing has a very high correlation to another over a time period, it could just be coincidence. But if it has no correlation, there is no causality. High correlation might come with causality, but it might not. It might come with coincidence. But low correlation means no causality, because if you actually have causality, they will move together or they'll move opposite together.

So, what I'm going to tell you is that if you take any reasonable time period of correlation against correlation of currency pricing, given currency against any of the topic matters that people talk about they're concerned about--inflation, stock price, GDP growth--you can go down the list, you'll see the correlations at most are low. And under the phraseology that I would use is a very technical finance term: flimsy.

Correlation shows you that currency strong or currency weak does not predict outcome on stocks. Never has. Now mind you, let me just step back. The fact that correlations are low doesn't mean you can't cherry pick a time when a currency move wasn't also coincident with a stock market being strong or weak, or an economy being strong or weak. You can cherry pick times for any random event. But for example, if you look at British pound sterling versus its stock market over almost any reasonable time, you can find--5-, 10-, 15-, 20-year periods-- the correlation comes to zero, showing you pure randomness. I mean, that's within 1/100 of a percent.

Why am I telling you this? I'm telling you this because that same basic thing, to a lesser or greater degree, is true for most things you can measure. But let me tell you about why. Let me tell you why there's no currency effect there. Pretty simple when you get right down to it.

Strong currency might inhibit your ability to export, because the pricier exports might be higher than it was before relative to the same thing from other nations. But few nations, and particularly not some of the big developed ones, are only making one or two things. They're making a lot of different kind of stuff, and they're buying inputs and their strong currency makes the exports more expensive to sell, but it makes the imports largely offset that. And in developed nations, the imports and the exports are not that far apart in America. Land of the free, home of the brave. You've got a lot of people that complain about our trade deficit, and I'm not going to go into all of that because that's not the topic of this talk. But remember that trade is small compared to services in America. And in fact, throughout the developed world. And in America, there's a surplus in services that offsets a lot of the trade deficit. But regardless, the totality of what's brought in versus what's put out as a percentage of GDP is tiny and all the fretting is already priced into everything else as the currencies move. Likewise, and I'll point out, and this is just a little minor point, if I'm a manufacturer of product category Y or category A through Z, I don't care which it is, and I'm very concerned that the currency may particularly hurt me because I either import or export a lot, and I don't have offsetting cost or sales as I just described before where the weak currency hurts me one way, helps me another. Global corporations are exceptionally super good in modern times at currency hedging, which is not that expensive. So they hedge away the risk. Therefore it doesn't have the effect.

So, going back to the beginning of this conversation, we know that there isn't a lot of causality of importance from strong or weak currencies, euro strong now, dollar weak now, because we know that the correlations are flimsy over any reasonable time that people measure. Are there short-term effects you can see? Yeah, sometimes. But for every short-term effect you can find, I can show you the exact reverse number of similar opposites.

So then, finally, I want to point out that weakness and strength is not as abnormal as people think it is. There's some tendency people have with currencies to be myopic and think that this move, whatever it is, up, down, is new, bigger, different than before. And yet, if you look at developed nations around the world, not necessarily less developed nations, and you look over a 40-year time period, their currency against other developed nations, basically just sine waves in long, irregular sweeping periods. And you can go ooh all you want about one period like this, but you wait 5 years and it does the reverse.

And in the long term, the dollar is where it was against sterling or most of the developed nation currencies 35 to 40 years ago, with the exception, of course, of the euro, which hadn't quite been created then, but in the time that the euro's been around. Even though each of these currencies will have periods for 3 or 4 years where they move against the other significantly without serious economic or overall stock market effect.

Thank you for listening to me. I hope you found this useful and beneficial.

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