In the last few years, we have become accustomed to solid positive equity returns. Your return so far, this year may not be as much as you have seen previously, yet you hear that the US Equity markets are up about 10% year to date.
What is going on?
There are a couple of factors at work here which have muted returns recently for Canadians investing in the US.
Since May, the US dollar (USD) has weakened significantly relative to the Canadian Dollar (CAD) from 1.3650 to 1.2432, an 8.9% drop. The good news is if you're planning a trip to the US this summer it will be a bit cheaper. Bad news is, until the US dollar gains a bit more strength our US$ returns are going to look a bit lame. What this means at the outset is that if you bought the entire US Equity market (either the Dow or S&P in an ETF for example) you are up 10% on the investment but in Canadian dollar terms you have lost 8.9% so the net gain is only (10% - 8.9%) 1.1%. Any US asset that you hold that is not hedged, even if you hold it in Canadian dollars, would experience this drop.
USD vs CAD May to Aug 2017. Source: Thomson One.
What about your Canadian holdings? The Canadian market has been much more muted than the US this year; it started off the year strongly but is down almost 5% since the high February 21st. Year to date at time of writing the TSX is a negative 1% return.
Foreign Exchange Hedging
One way to avoid drops in the USD is to hedge it back to CAD. Hedging eliminates any changes in the foreign exchange, and gains or losses are then solely dependent on the underlying assets. The problem is that it is prohibitively expensive to do this for individual holdings in a retail client account. So, if we feel that a particular sector or stock has great potential, we have to recognize that we would be taking on the USD risk as well. The alternative is to invest in Canadian equities in CAD but as sighted above the opportunities have been rather lackluster. In this kind of environment, we are a bit stuck between a rock and a hard place.
As a result, foreign exchange is always a factor we consider when making recommendations. When the CAD is strong, we definitely look to take advantage and have possibly multiple factors helping us gain returns. When the CAD is weak, we look to minimize foreign exchange exposure.
What should you do?
If you have US holdings, we recommend holding them. In fact, because of the recent strength of the CAD, for those who are underweight USD investments it may be time to buy in. We believe that the Canadian dollar is now at the upper end of a trading range which is running between US$0.74 and US$.80. We also believe that the USD headwind has abated for now, and that we should enjoy any gains in that market, and in fact be well positioned if the USD strengthens again.
We believe, barring any unforeseen event such as a war which we still be believe to be a low risk, that the US and Canadian markets will be higher at year end than they are currently. Hang tight!
If you are concerned, don’t hesitate to talk to us. That’s what we are here for!
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