Webcast #42: The Loonie Market (5 minutes)

If you’re watching the Canadian loonie, I bet you might be hesitant to travel south of the border any time soon. That’s because one loonie buys only $0.72 U.S. right now, down from $0.79 U.S. at the beginning of the year. However, that’s not because our local currency is weak on a global basis. For example, when you compare the loonie against the sterling or the euro, our currency is 11% and 6% more valuable than it was at the beginning of the year.

While the loonie is holding its own against other global currencies (mostly thanks to the strength in energy prices), the U.S. dollar is in a league of its own. When compared to a basket of seven other international currencies, the U.S. dollar is up almost 17% this year — its strongest performance in two decades.

The degree to which a stronger U.S. dollar will impact profits is about to become known. Almost 29% of revenues for the S&P 500 companies is generated overseas. At 59%, technology companies are most heavily exposed. Once a sale is made in a foreign country, the accountants convert the revenue back to the reporting currency (which is the U.S. dollar) for reflection in the quarterly financial statements. In other words, a higher U.S. dollar weakens the value of revenues generated overseas.

Debt held by emerging market countries is often priced in U.S. dollars. As local emerging market currencies weaken, their U.S. dollar debt becomes higher and more expensive to service.

However, there are two reasons not to be overly concerned. First, most companies hedge to some degree their currency exposure by utilizing derivative instruments. Second, believing that currency impacts neutralize over time, the market often overlooks the positive or negative impact of currency movements from quarter-to-quarter.

We expect the U.S. dollar strength to reverse as soon as the Federal Reserve signals to the market it is approaching the end of its rate hikes. While many expect that to be early in 2023, convincing evidence suggests that inflation on the ground has peaked and that further hikes are not required. Nevertheless, with the loonie at these levels relative to the U.S. dollar, unseen since the COVID-19 lows, we’re not adding new U.S. stocks right now.