The Huge Chain Reaction Driving Share Prices Higher
Stock-Markets / Investing 2009 Mar 17, 2009 - 12:52 PM GMT
Fundamentals have led a lot of investors into “value traps”. These are stocks that look cheap (i.e. with low price to earnings ratios) but more importantly have miserable prospects going forward. However, there's one indicator that continues to reveal winners despite the credit crunch…
It's time to look into the world of currencies.
I'm not talking about trading the foreign exchange markets. That requires deep pockets and a deep understanding of short-term chart strategies. I'm talking specifically of the positive influence that currency can have on corporate earnings.
Indeed, the weakness in the pound has been the best bailout for UK stocks so far…
The pros of a weak currency
If you think times are tough in the UK, take heart in knowing that things could be a lot worse.
National growth could fall as much as 5% this year. This is bad but it is better than Singapore, which is likely to collapse by 8% this year. This is not, as the numbers might hint, because Singaporean companies are significantly worse than UK firms. It's because the Sing dollar has fallen only 10% against the US dollar while the pound has fallen by 30%. Michael Dicks of Morgan Stanley suggests that the weak pound has benefitted the UK by as much as 3% of GDP… thank goodness.
If our currency were as stubborn as the Sing dollar, our recession would be just as deep if not worse. Currency swings have a profound impact on business but it often gets overlooked.
Look at British American Tobacco, Unilever or GlaxoSmithKline. Each of them is outpacing the FTSE 100 by at least 15% over the last year. That's not just the result of their defensive qualities. It's also as a result of the weak pound. These companies are based in the UK but they earn most of their money abroad. Every point the pound falls lines their pockets that little bit more.
This is the “currency chain reaction” that drives prices:
Share prices react to the earnings forecasts of City analysts. When investment banks publish their best guesses of future stock earnings, the share prices move. If the forecasts are positive the shares rally. If the earnings forecasts are negative the stocks tend to fall.
If a company operates all over the world, then currency swings will influence those earnings forecasts . When the pound falls, those stocks receive an earnings upgrade and the shares rally. By pre-empting those upgrades, you have a better chance of turning a profit than you do following traditional valuation metrics.
How you can profit from a falling yen
Unfortunately, as far as profiting from the weak pound is concerned, the ship has already sailed. Earnings forecasts are already factoring in the benefit of a weak pound for companies earning money overseas.
So the challenge is to identify the next region that is likely to record a fall in its currency. And then buy its most defensive stocks.
The US dollar is strong and shows no signs of falling back in the near term, so don't buy American stocks. And in Europe, the outlook is unclear. The euro could falter in the coming months but it has already fallen, so European stock markets are not ideal either.
Among developed markets, the stand-out country is Japan, which could be a good play…
The yen has been favoured as a “safe haven currency” in the last year. This is surprising because the economy is experiencing a very deep recession. Growth has contracted 12.5% at last count and exports by a shocking 45%.
The yen's strength has cost the Japanese economy even more than the pound's weakness has benefitted ours.
However, investors are starting to turn on the yen. While most believe that the dollar will stay strong, there is a growing consensus that the yen will soon fall. Weakness in the economy tends to correlate with a weakening currency.
If and when the yen falls, we could see another opportunity. To be clear, I am not advising you invest in a Japanese index tracker. Instead, look for stocks that earn their money in dollars and euros and pass the “sanity test” – in other words are good companies. That's where earnings forecasts and stock prices could both rally and make you money.
As the land of the rising sun becomes the land of the falling yen, it could signal the time to buy.
Best wishes,
By
Theo Casey,
http://www.fleetstreetinvest.co.uk
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