Forget for a moment how badly stocks have done this year. For investors in Asia, stock returns mean little without factoring in the outlook for the region’s currencies.
And that outlook isn’t so hot. So far in 2016, the dollar has fallen, the yen has climbed and the yuan has marked time. That’s produced a mixed bag of results for stocks, pulling down big Northeast Asian markets like China and South Korea alongside Tokyo amid fears a stronger yen will hurt everyone’s exports, but pushing up stocks in Southeast Asia like Indonesia as global investors pump funds back into relatively riskier markets. While the broader MSCI AC Asia index has fallen roughly 11%, therefore, the MSCI Southeast Asia index has lost only about 1%.
As Nomura’s currency strategist Craig Chan and his colleagues describe in their latest report, which way Asia’s currencies move will depend on the direction of just three: the U.S. dollar, the Japanese yen and China’s yuan. And where those go will depend on decisions at the U.S. Federal Reserve, the Bank of Japan and the People’s Bank of China.
Currency moves can be a double-edged sword for stocks. Experienced investors won’t have forgotten how a 9% gain in Japanese equities in 2014 turned into a 5%, U.S. dollar loss thanks to a 12% drop in the yen. That helped fuel the popularity of currency-hedged ETFs. But they’re not foolproof: thanks to the yen’s recent spurt, the un-hedged iShares MSCI Japan ETF ( EWJ ) has outperformed iShares Currency Hedged MSCI Japan (HEWJ ) by roughly 4.7 percentage points so far this year.
Both Taiwan and Malaysian stocks have dropped 1.9% so far this year. But thanks to a rising Malaysian ringgit and a falling Taiwan dollar, Malaysian stocks have returned 1.4% in U.S. dollar terms, whille Taiwan’s stocks have lost 4%. Indonesia’s 3.7% gain looks good, but its 6.9% gain in U.S. dollars looks even better.
This situation seems unlikely to last. The Fed appears convinced the U.S. economy is strong enough to justify at least some interest rate increases, the BOJ is determined to use negative interest rates to weaken the yen and restore growth, and the PBoC can onlyhold the yuan up so long against slowing growth and rising capital outflows.
http://www.barrons.com/articles/asian-stocks-caught-in-currency-war-crossfire-1455604366
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