Monday 19 March 2018

Paul Sommerville: Believing the consensus on strong dollar may be costly

The cliffs of Moher are a big draw for American tourists
The cliffs of Moher are a big draw for American tourists

Paul Sommerville

Last week it was reported by Tourism Ireland that over 1.6 million American and Canadian tourists visited Ireland in 2016. They hope to improve on this record-breaking number in 2017, targeting an increase in revenue from €1.4bn for the economy to €1.6bn in 2017.

The tourism industry is excelling itself and all involved should be applauded.

Among the visitors may be Barack Obama and it is interesting to note that his dollar salary will go 25pc further today in euro spending terms than when he previously visited in 2011.

In other words, USA tourists are 25pc better off in currency terms visiting Ireland today than they were in 2011.

The currency movements have been a great help in attracting US tourists and cushioning the blow in recent years because of what was often seen as poor value for money.

The dollar is not just appreciating against the euro but against most currencies. Recently the dollar index reached a 14-year high.

Since 2008 I have been dollar "bullish" when it was not a mainstream view and was considered a very contrarian call.

Nonetheless the dollar has increased in value throughout the post crisis.

The consensus arguments for its demise at that time were based on the notion that quantitative easing and zero interest rates would dilute the currency base.

That did not happen. Today, the consensus has come full circle. Analyst after analyst is declaring the era of the 'strong dollar' is upon us and the only way is up.

The argument is simple. The Federal Reserve is further along the rate cycle than other Central Banks and with Donald Trump now in the White House and inflation on the way, interest rates should rise faster in the USA quicker than the rest of the world so the dollar must get stronger.

If only currency markets were that simple. With the sentiment indicators so extreme that the dollar must get stronger, with the consensus so uniform in their opinion, now is a good time to contemplate that this may be nearing the end rather than the beginning of 'King Dollar'. If you have exposure to dollar earnings or are trying to manage dollar exposure, the first half of 2017 may be a good time to hedge that exposure.

I am starting to contemplate that the era of the strong dollar may be coming to an end and those cheering it now are some eight years too late.

For the tourist industry, they may well enjoy another summer of a strong dollar but must contemplate that what has been a massive tailwind could turn into a major headwind in 2018 and 2019 and plan accordingly.

The consensus in FX markets is the strong dollar is here to stay. The consensus is very rarely correct.

Panic now and avoid the rush later in US market

This week marks the anniversary of the end of the "great sell-off" of 2016 in global equity markets that nearly nobody remembers.

With worries over China throughout Christmas 2015, the markets plunged in early 2016 led by global mining stocks and followed by every asset class. Investors rushed for the exits fearing a China led implosion.

There was "blood on the streets" - I know more than most because some of it was my blood.

As a very contrarian call, I had advocated buying mining stocks in late 2015 as they had already had precipitous falls only to see the sell-off continue and intensify. With sentiment indicators in the sector so "off the charts" bearish we figured it was a good buying opportunity. In hindsight it was, but the volatility and intense nervousness meant that if the timing was not perfect then blood pressure and nerve had to be strong to go against the grain.

Those that did were vastly rewarded. Mining stocks such as BHP Billiton (the largest mining stock in the world) is up some 160 per cent since then and the mining sector is by far the best-performing sector of 2016.

The point is this: for investors, sentiment indicators are always reverse indicators at extremes. So anybody with any investments tied to the USA market should note that the weekly Investors Intelligence Advisors' Survey in USA this week showed a bullish percentage nearing 70pc.

This is the highest level of optimism in 30 years. The last time we were this high was just before the 1987 crash. The VIX index is showing levels of extreme complacency and by any measures the USA stock market is highly valued. For the last number of years I have been advocating that those exposed to the USA market should be decreasing exposure in an orderly fashion but we no longer believe you should be walking "calmly towards the exits". Every sentiment indicator is flashing red. This does not mean there is a crash due tomorrow but it is a clear and an unequivocal sign that it is a very precarious place to hold investments with a low probability of continued success.

I may be early with the call or may just be plain wrong and this time actually is different but, for me, the sentiment indicators are clear and unequivocal. You should panic now and avoid the rush later. Again I would expect some sectors to continue to do well but for the USA markets in general we suggest avoiding or reallocating resources elsewhere. If history teaches us anything it is better to be early than late.

BoE has swung from too gloomy to too optimistic

IN another embarrassing climbdown, the Bank of England made a further upgrade to economic growth forecasts for the UK.

After the referendum vote, it had cut the projections for GDP growth to 0.8pc but has now revised that to a more robust 2pc - quite a turnaround. Also, UK Consumer price inflation currently stands at 1.6pc and is expected to reach 2.7pc by the end of 2017.

In what was quite a self-congratulatory and circular argument, they cited their own action as the reason for the upgrades.

Regardless of the reasons, it is good news for Ireland that the performance of the UK economy has been much stronger than many a scaremonger would have predicted.

Also sterling has increased roughly 10pc in value from the very worst levels.

If the bank of England needs to put up interest rates, which is a possibility in latter part of 2017, then sterling strength may have more to go. More likely though is that the UK economy, while performing well thus far, will fail to reach the lofty heights painted for it in 2017.

While the early calls from the Bank of England were far too pessimistic, their latest calls are maybe on the optimistic side. From an Irish point of view it is comforting that the UK GDP performance has been robust thus far but we must plan for this to deteriorate towards the latter half of 2017.

Paul Sommerville is ceo of Sommerville Advisory Markets -

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