Ray Griffin
It’s clear that the most prominent financial topic in recent weeks and months has been the rising Australian Dollar (AUD). Judging by the tones and inflexions on the words of TV and radio newsreaders you could be forgiven for thinking that a rising AUD is great news for all of us - unfortunately this is not the case.
Economics is much like Isaac Newton’s third law of motion – “For every action there is an equal and opposite reaction” and, in the case of the rising AUD, it’s the equal and opposite effects which are generally being overlooked by newsreaders and sometimes overlooked by investors.
With most of world trade still denominated in American Dollars (USD), a rising AUD – against the USD – means that it takes less AUDs to import goods into Australia. This keeps ‘imported inflation’ (as it is sometimes called) at bay. It also means that Australians travelling overseas can buy foreign goods with less AUDs or more foreign goods for the same level of spending. By contrast, a rising AUD results in more of a foreign currency being required to buy Australian exports. This can reduce, or as a minimum disrupt, orders for Australian exports. It also requires inbound tourists to Australia to spend more of their currency to pay for their holidays in AUDs.
These – equal and opposite – actions ricochet through the whole economy resulting in reduced growth forecasts for many businesses but especially export driven businesses be they exporting goods and services or selling services to inbound tourists. This directly impacts profitability of Australian businesses with flow-on effects to employment.
So let’s bring this back to Australian investors. Managed funds which hold shares in export oriented businesses might see reduced growth prospects (from those shares) and possibly even lower dividends for a period of time while the businesses adjust to shoring up their export markets where possible. It also means that there will be little if any ‘currency dividend’ when investing in international share funds as was the case during the 1980s, 1990s and early part of this decade which arose simply by virtue of the AUD being quite volatile during those years (when the value of the AUD declines, the value of international investments rise in AUD terms).
By contrast, managed share funds which hold import oriented Australian businesses could see increased profitability from those companies (if the AUD maintains its value) as the cost of imports reduce in AUDs and as such the share prices of such companies could benefit and dividends might be strengthened. A managed fund which diversifies its holdings across a broad range of businesses will reduce risk of, for example, reliance on export business or import businesses.
From an investor’s perspective this changed climate for the AUD dictates a review of international allocations to portfolios. Note however that there is much more than currency issues in regard to what proportion of a portfolio should be allocated to international markets.
So, the next time you hear a news report on a rising AUD couched with inflexions of delight spare a thought for those in Australia who wish it wasn’t happening. And, as you hear various economic and market data being reported, consider whether there could be ‘an equal and opposite reaction’.
