“This year, at least, for the first half, we think the dollar will stay strong, as the Federal Reserve is still normalising [interest rates],” said Tai Hui, JP Morgan Asset Management’s chief market strategist in Asia, at a recent briefing in Hong Kong. He expected a 3-5% level up for the greenback.
“We think developed market equities offer better a risk/ reward profile [than emerging markets] over the next six-months.”
The currency is now the most expensively-valued among other key currencies in terms of the 10-year average of the real effective exchange rate (weighted average of a country’s currency relative to an index and adjusted for inflation), he noted.
“Since 2011, the dollar has been up about 40%. In the previous bull market, it was up about 47%. We think there’s a bit more to run.”
Hui argues that the dollar outlook is crucial for timing to invest in emerging markets.
“Historically, a strong dollar environment has not been particularly great for US dollar asset classes, even with developed market equities. But a stable or falling dollar provides a much better backdrop for risk assets.”
Still, investors with a long investment horizon who can stomach higher volatility can take advantage of cheaply-valued emerging market equities.
Stephen Lingard, Toronto-based portfolio manager at Franklin Templeton Solutions, shared a similar view.
He said the firm does not have a hard target for the US dollar, “but a 5% [upside] assumption is reasonable”, as the appreciation cycle is toward the end, he said in a briefing in Hong Kong yesterday.
EM vs DM
The cheap valuations of EM equities, in particular in Asia, could be a value trap amid risks such as more protectionism on trades, he added.
“We are not necessarily underweight emerging markets, but we are giving it a pause and giving it a neutral. It might be a good opportunity to weigh back into emerging markets if we see a dollar weakness, possibly later this year.”
Within developed market equities, Lingard prefers Japanese equities given what he sees as a solid economic recovery and a weak yen. “In Japan, where there is no political unrest, we have seen a tremendous rebound in earnings growth and the economy there is doing much better.”
JPMAM’s Hui said diversification is needed among US, Europe and Japanese equities. “We think the markets are understating the growth potential in Europe,” despite the negative news about upcoming elections. Some European export companies will also benefit from better US growth because they have a relatively lower probability of a trade dispute, he added.
Three-year performance of FTSE Developed versus FTSE Emerging index, according to FE.