The article “What The Loonie’s Roller Coaster Ride Means for Your Financial Planning” was originally published on Financial Post on June 26, 2017.
Jason Heath: Investors who have owned foreign investments have benefitted handsomely in recent years due to both performance and currency
It is hard to believe that just four years ago, the loonie was at par. Since then, the Canadian dollar has for the most part been in a downward trend and marked a 10-year low in early 2016 when it dipped below 70 cents.
On May 5, 2017, it hit another recent low point, at 72.5 cents.
In the past month, however, the loonie has jumped nearly 5 per cent and that has some people wondering if a more substantial rebound may be in the works, and what the roller coaster means for their financial planning.
The first thing to consider is how foreign exchange rates impact your saving and spending.
Canadian investors who have owned foreign investments have benefitted handsomely in recent years due to both performance and currency. The S&P 500 has grown 82 per cent in the past five years compared to just 33 per cent for the TSX. If we consider foreign exchange, the U.S. dollar has added another 28 per cent to the return for the S&P 500 for unhedged Canadian investors.
The total return of the MSCI World Index in Canadian dollars is a full 10 per cent higher than that of the TSX so far in 2017 and for emerging markets, the outperformance rises to 16 per cent.
A contrarian investor might think it is the wrong time to venture outside of Canada’s borders with their investments, but currencies are notoriously difficult to time. Foreign investments also help diversify an investment portfolio, particularly given how limited the TSX is in its exposure to healthcare, technology and consumer stocks.
For perspective, the Canada Pension Plan (CPP) asset mix as of March 31, 2017, included an 84 per cent exposure to global investments. This compares to just 18 per cent in 2000. Much of this exposure is to foreign public and private equities at 52 per cent.
For investors who are worried about currency, it is worth noting that the CPP does not worry about currency for the most part. Their logic is intuitive and worth considering as you make your investment decisions.
“For a Canadian investor,” says the CPP Investment Board (CPPIB), “hedging foreign equity returns reinforces, not reduces, their inherent risk. This is due to the Canadian dollar’s status as a commodity currency.”
If you are investing abroad to diversify away from the TSX and Canadian stocks, if you eliminate your foreign currency exposure by purchasing hedged or currency neutral mutual funds or exchange-traded funds, you are tying your returns in part back to the Canadian dollar. The Canadian dollar closely tracks the price of oil. And the price of oil has a high correlation to the TSX and Canadian energy stocks. Thus, hedging reduces the diversification benefit of investing abroad into non-Canadian stocks in the first place.
“The cost of hedging currencies of many developing countries is [also] prohibitively high,” notes the CPPIB. “We can substantially mitigate currency risks by holding a broadly diversified set of currency exposures across the world.”
From a spending perspective, a higher Canadian dollar makes imports cheaper, because Canadian dollars buy more U.S. dollars, Chinese yuan or euros. Cars are our main import by dollar volume, but a high proportion of Canada’s electronics, clothing and certain produce also come from abroad. A sustained higher Canadian dollar should mean lower prices for some of these imported goods.
Currency appreciation would also be good for Canadians looking to travel abroad. Many people who have taken vacations outside the country in recent years have seen their travel costs soar.
The statistics support the correlation between currency and travel. Statistics Canada reported that in 2016, Canadians travelling to the United States slumped for the third straight year, down 8 per cent from 2015. Meanwhile, non-U.S. travel has increased over the same period. Destinations of choice have been primarily countries whose currencies have been stable relative to the Canadian dollar, like Mexico, the U.K. and France.
Cross-border shopping has also taken a hit in recent years. The value of goods purchased by Canadians in the U.S. nearly doubled between 2006 and 2012 as the loonie roared to parity with the U.S. dollar. But since 2013, Canadian spending in the U.S. has been in decline. Historically, same-day trips to the U.S. are highly correlated to the Canada-U.S. exchange rate.
A higher Canadian dollar is beneficial for some kinds of spending but detrimental for others.
Foreign spending on Canadian exports tends to decrease as the Canadian dollar rises. Business that are exporting to the United States — which have benefited in recent years — are hoping that the rebound in the Canadian dollar is short-lived.
The falling Canadian dollar may have also been a boon for Canadian real estate, as a declining dollar meant that real estate was on sale for foreign buyers, despite rising home prices for local Canadians. The Chinese Yuan, for example, rose over 50 per cent relative to the Canadian dollar over a 5-year period ending in early 2016, a trend that has reversed in the past year.
So, what should you do?
When the Bank of Canada does its forecasting for the Canadian economy, it does not attempt to forecast the Canadian exchange rate. That does not mean that others do not try. RBC is the least optimistic of the Canadian banks, forecasting a 75-cent dollar by the end of 2018, while TD is most optimistic, estimating 78 cents. That is not a material change or range from where we stand today either way.
Look for prices of some Canadian imports to drop over the summer if a stronger Canadian dollar is here to stay. Canadians can only hope that the trend persists for the holiday shopping season and to help snowbirds’ vacation dollars stretch further.
From an investment perspective, consider unhedged foreign stock exposure as a means of diversifying your portfolio. The CPP invests your pension dollars abroad and despite attempts by pundits to predict the path of the dollar, remember that they do not try to themselves.
Jason Heath is a fee-only Certified Financial Planner (CFP) and income tax professional for Objective Financial Partners Inc. in Toronto, Ontario.