International Stock and Currency Issues

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rudeboy
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International Stock and Currency Issues

Post by rudeboy » Fri Apr 27, 2018 4:23 pm

I'm trying to understand the potential downsides/upsides of international diversification as it relates to currency issues. I've read that currency fluctuations are a risk factor with international stocks, but haven't been able to gain a full understanding this issue.

A specific question that comes to mind is: If the total non-US annual stock return for a given year is 10%, is it possible that due to 'currency issues,' this 10% return for a US investor will result in a <10% actualized return?

anil686
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Re: International Stock and Currency Issues

Post by anil686 » Fri Apr 27, 2018 4:38 pm

rudeboy wrote:
Fri Apr 27, 2018 4:23 pm
I'm trying to understand the potential downsides/upsides of international diversification as it relates to currency issues. I've read that currency fluctuations are a risk factor with international stocks, but haven't been able to gain a full understanding this issue.

A specific question that comes to mind is: If the total non-US annual stock return for a given year is 10%, is it possible that due to 'currency issues,' this 10% return for a US investor will result in a <10% actualized return?
Yes - you are correct. For example I think it was 2015 - the return of the international stock market in home currencies (ex-US) was about 6% - but the return for the US investor in dollars was negative. Of course, you could view it that with a stronger dollar, you are able to pick up more stocks and that over time currency fluctuations work their way out. Currency risk is (I don’t believe) a risk an investor is compensated for per se - so that matters - which is one of the reasons there are a gazillion international investing threads... Hope that helps...

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patrick013
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Re: International Stock and Currency Issues

Post by patrick013 » Fri Apr 27, 2018 4:46 pm

rudeboy wrote:
Fri Apr 27, 2018 4:23 pm
A specific question that comes to mind is: If the total non-US annual stock return for a given year is 10%, is it possible that due to 'currency issues,' this 10% return for a US investor will result in a <10% actualized return?
Of course, which is why Intl is so risky. Some theorists cite inflation,
interest rates, commodity prices, but I think the rates really fluctuate
due to exports and the strain payments make on Intl Bank reserves when
reserves would be better tied up in other investments than exchange
transactions, which limit choices for the Intl banks. Foreign transactions
require exchange transactions and the price is multi-factored and very
hard or impossible to predict.

So just have to wait and see about exchange rates during the year. Sometimes
foreign stocks do very well despite adverse exchange rates. Bond funds are
less likely to do very well as far as I have seen. My foreign AA would be less
than what VG suggests.
age in bonds, buy-and-hold, 10 year business cycle

lack_ey
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Re: International Stock and Currency Issues

Post by lack_ey » Fri Apr 27, 2018 4:46 pm

For most international stock funds, the stocks are primarily purchased in other stock markets in non-USD currencies (e.g. EUR, JPY, GBP, etc.). The return in USD terms is the local-currency return plus the foreign exchange rate change (okay, it's more like a multiplication, but I mean that these aspects are combined).

Over the very long run, we kind of expect the currency issues to have a relatively low impact on overall returns, there being little net difference, and not one that's predictable ahead of time. But over a course of a year, there can be a big difference between local currency return and the return we get.

It's possible to currency hedge to all but remove exposure to the fluctuating exchange rates, but most international funds do not. Some funds are available that do, though, but they're not traditionally recommended here (though I wouldn't call them a bad idea generally). The fund expense ratios tend to be a little bit higher, and the hedging itself is not costless, though for other major currencies it tends to be pretty cheap.

As one illustration, here's a look at rolling 12-month returns for an EAFE (most developed ex-US stocks) currency-hedged index fund, an EAFE index fund, and a fund that is long USDX futures (gains when USD strengthens against other currencies). There are a lot of issues with this comparison and some caveats with respect to fund costs, the USDX futures not really matching the basket of currencies in the stock funds, etc., but I think it should still be roughly informative.
Image
http://quotes.morningstar.com/chart/fun ... 22%3A12%7D

TomCat96
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Re: International Stock and Currency Issues

Post by TomCat96 » Fri Apr 27, 2018 4:47 pm

rudeboy wrote:
Fri Apr 27, 2018 4:23 pm
I'm trying to understand the potential downsides/upsides of international diversification as it relates to currency issues. I've read that currency fluctuations are a risk factor with international stocks, but haven't been able to gain a full understanding this issue.

A specific question that comes to mind is: If the total non-US annual stock return for a given year is 10%, is it possible that due to 'currency issues,' this 10% return for a US investor will result in a <10% actualized return?
When you purchase international stock, the international stock will by definition be denominated in the currency of its respective sovereign nation. That means you will be exposed to fluctuations in the currency if you cash out. Since you presumably have to cash out of foreign currency to dollars in order to spend it here, you assume the additional risk of the currency dropping or rising with respect to the dollar. (or whatever your home currency is)

The additional currency risk makes for some interesting situations.
For one, your international stocks could drop in value in their respective country yet still gain in your dollar denominated portfolio. I believe this is what occurred to a few members on this website in the immediate aftermath of Brexit.

The pound dropped as much as 11% against the dollar before rebounding sharply in the hours and days after. During the period of time when the pound was recovering, a few sterling denominated stocks dropped a few percentage points in their own respective currency. That drop was not enough to overcome the increase in value of the pound due to the recovery. As a result a few people on this site reported their dollar denominated international holdings actually went up on the day that their international stock went down.

So yes it is highly possible that due to "currency issues", your 10% return will be less than an actualized 10% return. Your investment in say for example a German company can rise 10% a year with respect to its German home market. But if the value of the German market as a whole has grown uncompetitive with respect to the global market, your purchasing power over here may not necessarily increase by 10%.

The converse is also true. So perhaps it's more accurate to say that when investing internationally, you are accepting another dimension of currency risk, even if it can be argued that you are diversifying away from your home country bias.

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Re: International Stock and Currency Issues

Post by nisiprius » Fri Apr 27, 2018 5:02 pm

Yes, rudeboy, you are correct. Currency fluctuation is an extra up-and-down fluctuation that is layered on top of the natural stock-market fluctuation in international stocks.

During 2000-2009, the famous "lost decade" when US stocks actually lost money (VTSMX, Total Stock, Blue) the Vanguard European Stock Index Fund, VEURX made money. (So did Total International but I'm using VEURX for a specific reason.)

Source

Image

Some of the difference was real, but most of it was due to the dollar weakening, which, measured in dollars, enhanced the value of European stocks. We can see this by asking Morningstar to replot the same chart, measuring in Euros. Measured in Euros, the European stock market lost money, just as the US market did.

Image

For an investor using US dollars, VEURX made over $2000. For an investor using Euros, VEURX lost almost 1,500 €. It's a big effect.

Measured in either currency, yes, the US underperformed Europe. But the difference was less than the differences caused by currency fluctuation.

Since 2008-2009, international stock funds have done poorly... when measured in dollars. And this is the result of the dollar strengthening.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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SimpleGift
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Re: International Stock and Currency Issues

Post by SimpleGift » Fri Apr 27, 2018 5:05 pm

rudeboy wrote:
Fri Apr 27, 2018 4:23 pm
I'm trying to understand the potential downsides/upsides of international diversification as it relates to currency issues. I've read that currency fluctuations are a risk factor with international stocks, but haven't been able to gain a full understanding this issue.
The most essential point, in my view, is that over long holding periods, the positive and negative impacts of currency fluctuations tend to balance each other out (chart below).
  • Image
    NOTE: Quarterly returns of MSCI EAFE USD Index vs. MSCI EAFE Local Currency Index, 1973 to 2016.
    Source: Fidelity
In fact from 1973-2016, according to Fidelity, currency hedging of international stocks would have detracted from returns in 50% of quarters, and contributed to returns in 50% of quarters.
Cordially, Todd

alex_686
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Re: International Stock and Currency Issues

Post by alex_686 » Fri Apr 27, 2018 5:09 pm

rudeboy wrote:
Fri Apr 27, 2018 4:23 pm
I've read that currency fluctuations are a risk factor with international stocks, but haven't been able to gain a full understanding this issue.
I too have studied this extensively and am confused. Can you point me to somebody or something that creditably defines the risk? O.K., I might be a bit harsh here but lets break this down.

Currency risk is bounded by Purchasing Power Parity (PPP) and thus mean reverting. This results in a atypical low risk profile. Inflation adjusted currency risk has a standard deviation of something like around 1% a year.

Equities tend to be a good hedge against inflation and currency. Next consider that about 1/2 of the S&P 500 revenue is international. Pick your international index and you will probably find a higher number.

I personally think that people think currency risk is high because they don't understand it and we assign higher than rational risk attributes to things that are complex.

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Lauretta
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Re: International Stock and Currency Issues

Post by Lauretta » Fri Apr 27, 2018 5:12 pm

lack_ey wrote:
Fri Apr 27, 2018 4:46 pm
the hedging itself is not costless
If you hedge your exposure to the Euro you actually 'get paid' more than 2%/yr at the moment (i.e. your fund hedged to USD should have a performance around 2% higher than in the local currency (euro) because rate differentials work in your favour). See the data for 2017 here:
https://www.msci.com/documents/10199/a4 ... 6e57d43130
I am actually in the opposite situation as I live in Euroland so I'd have to pay more than 2% to hedge my exposure to the US market. :(
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nisiprius
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Re: International Stock and Currency Issues

Post by nisiprius » Fri Apr 27, 2018 5:18 pm

alex_686 wrote:
Fri Apr 27, 2018 5:09 pm
...I personally think that people think currency risk is high because they don't understand it and we assign higher than rational risk attributes to things that are complex...
I personally think a lot of international advocates don't "get" it that uncompensated extra risk is bad even if it is bidirectional.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Lauretta
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Re: International Stock and Currency Issues

Post by Lauretta » Fri Apr 27, 2018 6:03 pm

alex_686 wrote:
Fri Apr 27, 2018 5:09 pm


Currency risk is bounded by Purchasing Power Parity (PPP) and thus mean reverting. This results in a atypical low risk profile.

Please correct me if I am wrong, but it seems to me that PPP and mean reversion could actually be used as an argument in favour of currency hedging. If the dollar is overvalued right now relative to the euro according to PPP (as shown by the Big Mac currency argument) then as a Eurozone investor investing now, and believing in mean reversion, it seems to make more sense to hedge my exposure to the dollar (because it will eventually mean revert from it overvaluation).
https://www.economist.com/content/big-mac-index
The PPP argument seems to make sense if at the time of investing the foreign currency is not overvalued: in that case you can argue that even if it fluctuates, it will eventually come back to the mean.
When everyone is thinking the same, no one is thinking at all

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SimpleGift
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Re: International Stock and Currency Issues

Post by SimpleGift » Fri Apr 27, 2018 6:37 pm

alex_686 wrote:
Fri Apr 27, 2018 5:09 pm
Currency risk is bounded by Purchasing Power Parity (PPP) and thus mean reverting.
Due to the mean reverting tendencies of Purchasing Power Parity, Dimson, Marsh and Staunton have pointed out that, over the long haul, currencies essentially reflect relative inflation rates (chart below). For long-term investors who are concerned about the purchasing power of their investments, this creates an often overlooked benefit from the currency exposure of foreign equities.
In short, unhedged foreign currency exposure offers protection against unexpected inflation in one's own country.
Cordially, Todd

rudeboy
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Re: International Stock and Currency Issues

Post by rudeboy » Fri Apr 27, 2018 7:44 pm

You all are a bottomless trove of knowledge! Thanks.

chatbotte
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Re: International Stock and Currency Issues

Post by chatbotte » Fri Apr 27, 2018 7:53 pm

SimpleGift wrote:
Fri Apr 27, 2018 6:37 pm
In short, unhedged foreign currency exposure offers protection against unexpected inflation in one's own country.
Unless the price of domestic non-tradables rises faster than the price of domestic tradables. In this scenario, PPP will hold for tradables, but you'll have domestic non-tradables inflation that's not offset by the nominal exchange rate.

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Re: International Stock and Currency Issues

Post by whodidntante » Fri Apr 27, 2018 7:58 pm

I don't assume the dollar will remain at current strength for my lifetime, and I might retire elsewhere. It's a risk reduction for me to hold international stocks.

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SimpleGift
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Re: International Stock and Currency Issues

Post by SimpleGift » Fri Apr 27, 2018 9:09 pm

chatbotte wrote:
Fri Apr 27, 2018 7:53 pm
SimpleGift wrote:
Fri Apr 27, 2018 6:37 pm
In short, unhedged foreign currency exposure offers protection against unexpected inflation in one's own country.
Unless the price of domestic non-tradables rises faster than the price of domestic tradables. In this scenario, PPP will hold for tradables, but you'll have domestic non-tradables inflation that's not offset by the nominal exchange rate.
One can imagine scenarios where unhedged foreign currency exposure wouldn't work against unexpected inflation — but it certainly helped in the late 1970s, during a classic period of unexpected inflation in the U.S. (see Fidelity chart upthread).
Cordially, Todd

alex_686
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Re: International Stock and Currency Issues

Post by alex_686 » Sat Apr 28, 2018 1:15 pm

Lauretta wrote:
Fri Apr 27, 2018 6:03 pm
alex_686 wrote:
Fri Apr 27, 2018 5:09 pm


Currency risk is bounded by Purchasing Power Parity (PPP) and thus mean reverting. This results in a atypical low risk profile.

Please correct me if I am wrong, but it seems to me that PPP and mean reversion could actually be used as an argument in favour of currency hedging. If the dollar is overvalued right now relative to the euro according to PPP (as shown by the Big Mac currency argument) then as a Eurozone investor investing now, and believing in mean reversion, it seems to make more sense to hedge my exposure to the dollar (because it will eventually mean revert from it overvaluation).
https://www.economist.com/content/big-mac-index
The PPP argument seems to make sense if at the time of investing the foreign currency is not overvalued: in that case you can argue that even if it fluctuates, it will eventually come back to the mean.
When I last checked this was not an exploitable anomonially. Or rather, one has to have a time frame of over 10 years to pick up an extra percentage point or two in gains. Over factors tend to swamp the PPP issues.

PPP can be out of whack for long periods of time. Just because a currency is overvalued does not mean it will return to its fair value - it can persist to be overvalued for a very long stretch. Then there is thhe issue that PPP is a estimated value - like inflation - not a hard value. PPP measures inflation, sort of. You exploited currency moves with futures, which are based on government bonds. Yes, there are casual and correlation relationships between government bonds and inflation but it is not prefect.

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Re: International Stock and Currency Issues

Post by 3funder » Sat Apr 28, 2018 2:45 pm

Over the long-term, currency fluctuations have little effect. In the short-term, the effect could be quite noticeable.

chatbotte
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Re: International Stock and Currency Issues

Post by chatbotte » Sat Apr 28, 2018 4:54 pm

Lauretta wrote:
Fri Apr 27, 2018 6:03 pm
alex_686 wrote:
Fri Apr 27, 2018 5:09 pm


Currency risk is bounded by Purchasing Power Parity (PPP) and thus mean reverting. This results in a atypical low risk profile.

Please correct me if I am wrong, but it seems to me that PPP and mean reversion could actually be used as an argument in favour of currency hedging. If the dollar is overvalued right now relative to the euro according to PPP (as shown by the Big Mac currency argument) then as a Eurozone investor investing now, and believing in mean reversion, it seems to make more sense to hedge my exposure to the dollar (because it will eventually mean revert from it overvaluation).
https://www.economist.com/content/big-mac-index
The PPP argument seems to make sense if at the time of investing the foreign currency is not overvalued: in that case you can argue that even if it fluctuates, it will eventually come back to the mean.
Lauretta wrote:
Fri Apr 27, 2018 5:12 pm
lack_ey wrote:
Fri Apr 27, 2018 4:46 pm
the hedging itself is not costless
If you hedge your exposure to the Euro you actually 'get paid' more than 2%/yr at the moment (i.e. your fund hedged to USD should have a performance around 2% higher than in the local currency (euro) because rate differentials work in your favour). See the data for 2017 here:
https://www.msci.com/documents/10199/a4 ... 6e57d43130
I am actually in the opposite situation as I live in Euroland so I'd have to pay more than 2% to hedge my exposure to the US market. :(
Lauretta,

Lets assume the UIP holds. The U.S. nominal interest rate is 2 percentage points higher than the nominal interest rate in the euro area. You expect the same nominal return on your EUR holdings and USD holdings when you bring them back into EUR, because USD is expected to lose 2 percent of its external value, offsetting the higher interest rate in the U.S.

Conversely, a U.S. investor expects to get 2 percentage points more on their EUR holdings when they bring them back into USD, because the euro is expected to buy 2 percent more dollars.

A higher inflation rate is usually associated with a higher nominal interest rate: imagine the U.S. inflation rate is 3 percent, the nominal interest rate in the U.S. is 5 percent, the euro area inflation rate is 1 percent, and the euro area nominal interest rate is 3 percent. In that case, both you and the U.S. investor expect to get the same real return, or 2 percent, on your USD as well as EUR holdings when you bring them back into your respective domestic currencies.

So, no need to get sad. :)

pascalwager
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Re: International Stock and Currency Issues

Post by pascalwager » Sun Apr 29, 2018 2:36 pm

nisiprius wrote:
Fri Apr 27, 2018 5:18 pm
alex_686 wrote:
Fri Apr 27, 2018 5:09 pm
...I personally think that people think currency risk is high because they don't understand it and we assign higher than rational risk attributes to things that are complex...
I personally think a lot of international advocates don't "get" it that uncompensated extra risk is bad even if it is bidirectional.
My understanding is that currency risk applies in the short-term, but not the long-term. In the long-term, currency fluctuations balance out to nothing, so risk compensation is not needed. We're warned not to hold stocks for the short-term and I guess this doubles for int'l stocks.

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Lauretta
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Re: International Stock and Currency Issues

Post by Lauretta » Sun Apr 29, 2018 2:45 pm

pascalwager wrote:
Sun Apr 29, 2018 2:36 pm
nisiprius wrote:
Fri Apr 27, 2018 5:18 pm
alex_686 wrote:
Fri Apr 27, 2018 5:09 pm
...I personally think that people think currency risk is high because they don't understand it and we assign higher than rational risk attributes to things that are complex...
I personally think a lot of international advocates don't "get" it that uncompensated extra risk is bad even if it is bidirectional.
My understanding is that currency risk applies in the short-term, but not the long-term. In the long-term, currency fluctuations balance out to nothing, so risk compensation is not needed. We're warned not to hold stocks for the short-term and I guess this doubles for int'l stocks.
yes but still it seems to me that if you invest a lump sum now in a stock market whose currency is significantly overvalued (as judged by PPP), say the Swiss stock market, the mean reversion argument suggests that over the long haul the swiss franc will probably be significantly devalued to get back to some value around the mean, so that you are likely to suffer because of this, even if you have a long term horizon
https://www.economist.com/content/big-mac-index
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Re: International Stock and Currency Issues

Post by pascalwager » Sun Apr 29, 2018 6:38 pm

Lauretta wrote:
Sun Apr 29, 2018 2:45 pm
pascalwager wrote:
Sun Apr 29, 2018 2:36 pm
nisiprius wrote:
Fri Apr 27, 2018 5:18 pm
alex_686 wrote:
Fri Apr 27, 2018 5:09 pm
...I personally think that people think currency risk is high because they don't understand it and we assign higher than rational risk attributes to things that are complex...
I personally think a lot of international advocates don't "get" it that uncompensated extra risk is bad even if it is bidirectional.
My understanding is that currency risk applies in the short-term, but not the long-term. In the long-term, currency fluctuations balance out to nothing, so risk compensation is not needed. We're warned not to hold stocks for the short-term and I guess this doubles for int'l stocks.
yes but still it seems to me that if you invest a lump sum now in a stock market whose currency is significantly overvalued (as judged by PPP), say the Swiss stock market, the mean reversion argument suggests that over the long haul the swiss franc will probably be significantly devalued to get back to some value around the mean, so that you are likely to suffer because of this, even if you have a long term horizon
https://www.economist.com/content/big-mac-index
Long-term, the Swiss Franc may once again be overvalued. Also, the Swiss market is only 2.4% of the world market, and country diversification is desirable. Using BH siamond's global/domestic portfolio (75% world/25% domestic), an Italian or U.S. investor would only hold 1.8% Swiss market. His study considered currency dynamics and produced improved results compared to an Italian investor holding 100% domestic.

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Re: International Stock and Currency Issues

Post by AlohaJoe » Sun Apr 29, 2018 7:52 pm

alex_686 wrote:
Fri Apr 27, 2018 5:09 pm
Currency risk is bounded by Purchasing Power Parity (PPP) and thus mean reverting.
SimpleGift wrote:
Fri Apr 27, 2018 6:37 pm
Due to the mean reverting tendencies of Purchasing Power Parity, Dimson, Marsh and Staunton have pointed out that, over the long haul, currencies essentially reflect relative inflation rates (chart below).
Both of the above statements are not exactly true. No one understands exchange rates and anyone who tells you otherwise is fibbing. There is nothing close to agreement within the economics profession when it comes to the theories underlying exchange rates.

(All quotes are from a 2016 survey on exchange rate theories; emphasis added.)
Bluntly said, realistic forecasts are impossible, and the economics professions is unable to explain exchange rates, one of the most important prices in modern economies. For the long run, opinions about explanations and trends differ. Obviously exchange rates are enigmatic or chaotic. Mainstream economics is in deep crisis regarding exchange rate theory.
One reason why the author of the above quote calls it a "crisis" is because of the inability of any leading theory to explain why the Euro appreciated 88% against the Dollar from 2001-2008. Purchasing Power Parity, Interest Rate Parity, and current accounts, national output, etc...none of them can account for a shift of that magnitude. So we're not talking about small market failures for minor, thinly traded currencies.

The Purchasing Power Parity theory is certainly one theory, though many academics scoff at it -- primarily because it can't actually explain real world exchange rates.
[Blanchard & Johnson's textbook] follow also the Interest Rate Parity theory which is considered key for the short and medium term. Purchasing Power Parity theory is briefly mentioned but rejected as it cannot explain empirically observed exchange rates.
The most charitable view of the Purchasing Power Parity theory of exchange rates is:
Empirical evidence would have taught readers that strong deviation [from the Purchasing Power Parity theory] is the rule, and compliance the exception, at least on the deepest forex markets, the dollar-yen and the dollar euro market (cp. Priewe 2016). Periods of deviation are often long. This need not imply that Purchasing Power Parity is a false theory per se – it could be a sensible target, but floating exchange rates are driven by other factors.
Interest Rate Parity (which is what DMS are talking about in SimpleGift's post) is another theory but it also has empirical issues, isn't universally accepted, and has competitors. Other competitors include things like a general macroeconomic equilibrium equation taking into account employment and price levels, the Mundell-Fleming model (which takes into account, among other things, national output), behavioural expectations around future interest & exchange rates, capital flows, and more.

The economics textbook by Krugman, Obstfeld, and Melitz spends 225 pages on exchange rate theories so anyone who tries to tell you it is a simple subject with an open & shut answer is being misleading.

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Re: International Stock and Currency Issues

Post by SimpleGift » Sun Apr 29, 2018 8:10 pm

AlohaJoe wrote:
Sun Apr 29, 2018 7:52 pm
No one understands exchange rates and anyone who tells you otherwise is fibbing. There is nothing close to agreement within the economics profession when it comes to the theories underlying exchange rates.
AlohaJoe, thank you for taking the time to clarify in such detail the confusion of the economics profession around exchange rate theories. In my case, I was more-or-less blindly following the lead of Dimson, Marsh and Staunton — whose annual Yearbook articles probably deserve more critical examination than I have the expertise to apply! Appreciate your clarifications.
Cordially, Todd

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Re: International Stock and Currency Issues

Post by AlohaJoe » Sun Apr 29, 2018 8:35 pm

AlohaJoe wrote:
Sun Apr 29, 2018 7:52 pm
The economics textbook by Krugman, Obstfeld, and Melitz spends 225 pages on exchange rate theories so anyone who tries to tell you it is a simple subject with an open & shut answer is being misleading.
I should add that in my own personal investing I basically bury my head in the sand when it comes to currency issues due to being overwhelmed when i tried to research what "the right thing to do" is. And I am highly exposed to currency issues, since the majority of my assets are in USD but I live in Vietnam. :shock: Of course, I've never found a hedge for retail investors in VND anyway, so it is all a bit theoretical for me.....

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Re: International Stock and Currency Issues

Post by rudeboy » Sun Apr 29, 2018 9:26 pm

AlohaJoe wrote:
Sun Apr 29, 2018 7:52 pm

The economics textbook by Krugman, Obstfeld, and Melitz spends 225 pages on exchange rate theories so anyone who tries to tell you it is a simple subject with an open & shut answer is being misleading.
Thank you for this reply AlohaJoe (the whole thing, but especially this bit).

I think I have heard both Jack Bogle and Warren Buffett advise not to invest in what you don't understand. Perhaps the muddiness of exchange rate theories are a reason why? I'm curious how other Bogleheads justify an international allocation given the complexities of currency exchange.

For the record, I have a very small international allocation at the moment, which I did as a test run to see if, experientially, I am comfortable with holding international stock. But I have to admit it is more of a fear-based than knowledge-based decision.

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Re: International Stock and Currency Issues

Post by AlohaJoe » Sun Apr 29, 2018 9:34 pm

rudeboy wrote:
Sun Apr 29, 2018 9:26 pm
I think I have heard both Jack Bogle and Warren Buffett advise not to invest in what you don't understand.
I don't think this is really useful advice. How many people invest in Total Bond Market? How many actually understand mortgage backed securities? Heck, I bet only a vanishingly small percentage of Bogleheads even understand Treasuries.

If you invest in the Total Stock Market does that mean you need to understand the business of every company? When I worked in a public company I barely understood what my division did.

Whenever someone tries to make advice too simple they end up robbing the advice of any usefulness.

Plus, American companies are exposed to exchange rates, so you still "need to understand them" if you want to "understand" U.S. equities.

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Lauretta
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Re: International Stock and Currency Issues

Post by Lauretta » Mon Apr 30, 2018 3:42 am

pascalwager wrote:
Sun Apr 29, 2018 6:38 pm
Lauretta wrote:
Sun Apr 29, 2018 2:45 pm
pascalwager wrote:
Sun Apr 29, 2018 2:36 pm
nisiprius wrote:
Fri Apr 27, 2018 5:18 pm
alex_686 wrote:
Fri Apr 27, 2018 5:09 pm
...I personally think that people think currency risk is high because they don't understand it and we assign higher than rational risk attributes to things that are complex...
I personally think a lot of international advocates don't "get" it that uncompensated extra risk is bad even if it is bidirectional.
My understanding is that currency risk applies in the short-term, but not the long-term. In the long-term, currency fluctuations balance out to nothing, so risk compensation is not needed. We're warned not to hold stocks for the short-term and I guess this doubles for int'l stocks.
yes but still it seems to me that if you invest a lump sum now in a stock market whose currency is significantly overvalued (as judged by PPP), say the Swiss stock market, the mean reversion argument suggests that over the long haul the swiss franc will probably be significantly devalued to get back to some value around the mean, so that you are likely to suffer because of this, even if you have a long term horizon
https://www.economist.com/content/big-mac-index
Long-term, the Swiss Franc may once again be overvalued. Also, the Swiss market is only 2.4% of the world market, and country diversification is desirable. Using BH siamond's global/domestic portfolio (75% world/25% domestic), an Italian or U.S. investor would only hold 1.8% Swiss market. His study considered currency dynamics and produced improved results compared to an Italian investor holding 100% domestic.
thanks for the feedback. The Swiss franc was just an example of course. The USD was another case that was overvalued relative to my currency (the Euro) when I invested a lump sum over a yr ago. I didn't hedge and since then the dollar has lost ~10% relative to the Euro (and according to PPP it' still overvalued). Luckily I have much less stocks in the US than I would have if I used a global market cap weighted allocation, otherwise half of my stocks would have suffered from this high devaluation of the USD. Having ~50% of one's stocks allocation in stocks denominated in a foreign currency (which is what happens if a non US investor (say from Italy like myself) allocates according to the weights of MSCI world) seems to me to produce a portfolio too vulnerable to the EUR/USD fluctuations.
Yes I will look at the study you mention (do you have a link?), what you say about en Italian investor historically does make sense since the lira (before the euro) was continuously devalued.
Last edited by Lauretta on Mon Apr 30, 2018 3:45 am, edited 1 time in total.
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chatbotte
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Re: International Stock and Currency Issues

Post by chatbotte » Mon Apr 30, 2018 4:01 am

Lauretta,
Lauretta wrote:
Mon Apr 30, 2018 3:42 am
thanks for the feedback. The Swiss franc was just an example of course. The USD was another case that was overvalued relative to my currency (the Euro) when I invested a lump sum over a yr ago. I didn't hedge and since then the dollar has lost ~10% relative to the Euro (and according to PPP it' still overvalued). Luckily I have much less stocks in the US than I would have if I used a global market cap weighted allocation, otherwise half of my stocks would have suffered from this high devaluation of the USD. Having ~50% of one's stocks allocation in stocks denominated in a foreign currency (which is what happens if a non US investor (say from Italy like myself) allocates according to the weights of MSCI world) seems to me to produce a portfolio too vulnerable to the EUR/USD fluctuations.
Yes I will look at the study you mention (do you have a link?), what you say about en Italian investor historically does make sense since the lira (before the euro) was continuously devalued.
You've got it all wrong. PPP cannot hold in the short run, because (a) it takes time to arbitrage away price differences (ever imported anything from the U.S. to the euro area?), and (b) some (possibly a lot of) goods aren't traded. You cannot import a dentist from Denver, Colorado to Zurich, Switzerland as soon as real wages (i.e. prices for dental services) go up in Zurich. So that price difference will remain, and to the extent it is part of a CPI, it's going to make PPP invalid when you test it on data.

According to Vanguard, it's best to model short-term currency rates as random walks: knowledge of the past doesn't make the future any more certain.

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Lauretta
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Re: International Stock and Currency Issues

Post by Lauretta » Mon Apr 30, 2018 4:17 am

chatbotte wrote:
Mon Apr 30, 2018 4:01 am
Lauretta,
Lauretta wrote:
Mon Apr 30, 2018 3:42 am
thanks for the feedback. The Swiss franc was just an example of course. The USD was another case that was overvalued relative to my currency (the Euro) when I invested a lump sum over a yr ago. I didn't hedge and since then the dollar has lost ~10% relative to the Euro (and according to PPP it' still overvalued). Luckily I have much less stocks in the US than I would have if I used a global market cap weighted allocation, otherwise half of my stocks would have suffered from this high devaluation of the USD. Having ~50% of one's stocks allocation in stocks denominated in a foreign currency (which is what happens if a non US investor (say from Italy like myself) allocates according to the weights of MSCI world) seems to me to produce a portfolio too vulnerable to the EUR/USD fluctuations.
Yes I will look at the study you mention (do you have a link?), what you say about en Italian investor historically does make sense since the lira (before the euro) was continuously devalued.
You've got it all wrong. PPP cannot hold in the short run, because (a) it takes time to arbitrage away price differences (ever imported anything from the U.S. to the euro area?), and (b) some (possibly a lot of) goods aren't traded. You cannot import a dentist from Denver, Colorado to Zurich, Switzerland as soon as real wages (i.e. prices for dental services) go up in Zurich. So that price difference will remain, and to the extent it is part of a CPI, it's going to make PPP invalid when you test it on data.

According to Vanguard, it's best to model short-term currency rates as random walks: knowledge of the past doesn't make the future any more certain.
Yes what I mean is hat if PPP holds in the long term, and I buy a big amount of US stocks now that the USD is overvalued relative to the Euro, mean reversion in the long terms suggests that I am more likely than not to lose from the exchange rates when I sell th US stocks 20 yrs from now, if in the long term you are likely to have mean reversion.
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chatbotte
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Re: International Stock and Currency Issues

Post by chatbotte » Mon Apr 30, 2018 4:25 am

Lauretta wrote:
Mon Apr 30, 2018 4:17 am
chatbotte wrote:
Mon Apr 30, 2018 4:01 am
Lauretta,
Lauretta wrote:
Mon Apr 30, 2018 3:42 am
thanks for the feedback. The Swiss franc was just an example of course. The USD was another case that was overvalued relative to my currency (the Euro) when I invested a lump sum over a yr ago. I didn't hedge and since then the dollar has lost ~10% relative to the Euro (and according to PPP it' still overvalued). Luckily I have much less stocks in the US than I would have if I used a global market cap weighted allocation, otherwise half of my stocks would have suffered from this high devaluation of the USD. Having ~50% of one's stocks allocation in stocks denominated in a foreign currency (which is what happens if a non US investor (say from Italy like myself) allocates according to the weights of MSCI world) seems to me to produce a portfolio too vulnerable to the EUR/USD fluctuations.
Yes I will look at the study you mention (do you have a link?), what you say about en Italian investor historically does make sense since the lira (before the euro) was continuously devalued.
You've got it all wrong. PPP cannot hold in the short run, because (a) it takes time to arbitrage away price differences (ever imported anything from the U.S. to the euro area?), and (b) some (possibly a lot of) goods aren't traded. You cannot import a dentist from Denver, Colorado to Zurich, Switzerland as soon as real wages (i.e. prices for dental services) go up in Zurich. So that price difference will remain, and to the extent it is part of a CPI, it's going to make PPP invalid when you test it on data.

According to Vanguard, it's best to model short-term currency rates as random walks: knowledge of the past doesn't make the future any more certain.
Yes what I mean is hat if PPP holds in the long term, and I buy a big amount of US stocks now that the USD is overvalued relative to the Euro, mean reversion in the long terms suggests that I am more likely than not to lose from the exchange rates when I sell th US stocks 20 yrs from now, if in the long term you are likely to have mean reversion.
So why are you talking about an annual loss? It was a random occurrence. Could have gone the other way.

I understand the logic of your PPP mean reversion argument. However, PPP failed to explain the perceived rise (overvaluation) as well as the recent drop that you're worried about. So maybe PPP isn't a good short-term theory of exchange rates.

Valuethinker
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Re: International Stock and Currency Issues

Post by Valuethinker » Mon Apr 30, 2018 7:23 am

chatbotte wrote:
Mon Apr 30, 2018 4:01 am
Lauretta,
Lauretta wrote:
Mon Apr 30, 2018 3:42 am
thanks for the feedback. The Swiss franc was just an example of course. The USD was another case that was overvalued relative to my currency (the Euro) when I invested a lump sum over a yr ago. I didn't hedge and since then the dollar has lost ~10% relative to the Euro (and according to PPP it' still overvalued). Luckily I have much less stocks in the US than I would have if I used a global market cap weighted allocation, otherwise half of my stocks would have suffered from this high devaluation of the USD. Having ~50% of one's stocks allocation in stocks denominated in a foreign currency (which is what happens if a non US investor (say from Italy like myself) allocates according to the weights of MSCI world) seems to me to produce a portfolio too vulnerable to the EUR/USD fluctuations.
Yes I will look at the study you mention (do you have a link?), what you say about en Italian investor historically does make sense since the lira (before the euro) was continuously devalued.
You've got it all wrong. PPP cannot hold in the short run, because (a) it takes time to arbitrage away price differences (ever imported anything from the U.S. to the euro area?), and (b) some (possibly a lot of) goods aren't traded. You cannot import a dentist from Denver, Colorado to Zurich, Switzerland as soon as real wages (i.e. prices for dental services) go up in Zurich. So that price difference will remain, and to the extent it is part of a CPI, it's going to make PPP invalid when you test it on data.
A small addendum. Medical tourism is happening. Fascinating to watch just how many services *can* be outsourced across borders. My radiology in the middle of the night in A&E in London was done in Sydney (analysis).
According to Vanguard, it's best to model short-term currency rates as random walks: knowledge of the past doesn't make the future any more certain.
It is correct that there seems to be no better forecasting model.

dknightd
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Re: International Stock and Currency Issues

Post by dknightd » Mon Apr 30, 2018 7:44 am

rudeboy wrote:
Fri Apr 27, 2018 4:23 pm
I'm trying to understand the potential downsides/upsides of international diversification as it relates to currency issues. I've read that currency fluctuations are a risk factor with international stocks, but haven't been able to gain a full understanding this issue.

A specific question that comes to mind is: If the total non-US annual stock return for a given year is 10%, is it possible that due to 'currency issues,' this 10% return for a US investor will result in a <10% actualized return?
I would be surprised if a 10% gain in non-US stocks could result in a 10% loss in $US. But suppose it is possible. And perhaps it has happened, I don't track it carefully. It is also possible that a 10% gain in non-US stocks could result in a 15% increase in $US.

I don't understand how or why a $US raises or falls compared to another country. I think it might be determined by which currency people worldwide would rather hold.

As we head more and more toward a global economy, it makes sense to me to have at least some exposure to this.

chatbotte
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Re: International Stock and Currency Issues

Post by chatbotte » Mon Apr 30, 2018 8:45 am

dknightd,
dknightd wrote:
Mon Apr 30, 2018 7:44 am
I would be surprised if a 10% gain in non-US stocks could result in a 10% loss in $US. But suppose it is possible. And perhaps it has happened, I don't track it carefully. It is also possible that a 10% gain in non-US stocks could result in a 15% increase in $US.
TSX seems to have gained about 23 percent and CADUSD seems to have lost 24 percent over the past 5 years, which translates into a loss of about 1 percent for a U.S. investor:

log(TSXnow)-log(TSXbackthen)+log(CADUSDnow)-log(CADUSDbackthen)=log(15692.26)-log(12438.03)+log(0.7782)-log(0.9931)=-1%

[On second thought, I don't think it includes dividends. I think it's the price series of the index, not a total return. The level would have been much higher if it were the total return series.]
Last edited by chatbotte on Mon Apr 30, 2018 12:27 pm, edited 2 times in total.

chatbotte
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Re: International Stock and Currency Issues

Post by chatbotte » Mon Apr 30, 2018 9:22 am

AlohaJoe,
AlohaJoe wrote:
Sun Apr 29, 2018 7:52 pm
The economics textbook by Krugman, Obstfeld, and Melitz spends 225 pages on exchange rate theories so anyone who tries to tell you it is a simple subject with an open & shut answer is being misleading.
Surely there's a theory that best describes rates. That's what you have at the moment, and must stick to. That's the way science works: you don't discard an imperfect theory just because it's not perfect enough, as per your subjective judgment. It must be supplanted by something better.

Vanguard says random walk in the short term, so I stick with that. In the long term, real rates oscillating around complete PPP (RER=1) within reasonable bounds seems to be a sensible proposition, at all times. Not sure you can have tradables prices in the U.S. five times the prices of tradables in Canada, with a high probability of that event. So my take on this is that real rates move up and down around 1, with a meaningful probability distribution, and five-times-the-foreign-price really is a very unlikely (tail) event.

alex_686
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Re: International Stock and Currency Issues

Post by alex_686 » Tue May 01, 2018 2:06 pm

AlohaJoe wrote:
Sun Apr 29, 2018 7:52 pm
alex_686 wrote:
Fri Apr 27, 2018 5:09 pm
Currency risk is bounded by Purchasing Power Parity (PPP) and thus mean reverting.
SimpleGift wrote:
Fri Apr 27, 2018 6:37 pm
Due to the mean reverting tendencies of Purchasing Power Parity, Dimson, Marsh and Staunton have pointed out that, over the long haul, currencies essentially reflect relative inflation rates (chart below).
Both of the above statements are not exactly true. No one understands exchange rates and anyone who tells you otherwise is fibbing. There is nothing close to agreement within the economics profession when it comes to the theories underlying exchange rates.

(All quotes are from a 2016 survey on exchange rate theories; emphasis added.)
Bluntly said, realistic forecasts are impossible, and the economics professions is unable to explain exchange rates, one of the most important prices in modern economies. For the long run, opinions about explanations and trends differ. Obviously exchange rates are enigmatic or chaotic. Mainstream economics is in deep crisis regarding exchange rate theory.
One reason why the author of the above quote calls it a "crisis" is because of the inability of any leading theory to explain why the Euro appreciated 88% against the Dollar from 2001-2008. Purchasing Power Parity, Interest Rate Parity, and current accounts, national output, etc...none of them can account for a shift of that magnitude. So we're not talking about small market failures for minor, thinly traded currencies.

The Purchasing Power Parity theory is certainly one theory, though many academics scoff at it -- primarily because it can't actually explain real world exchange rates.
[Blanchard & Johnson's textbook] follow also the Interest Rate Parity theory which is considered key for the short and medium term. Purchasing Power Parity theory is briefly mentioned but rejected as it cannot explain empirically observed exchange rates.
The most charitable view of the Purchasing Power Parity theory of exchange rates is:
Empirical evidence would have taught readers that strong deviation [from the Purchasing Power Parity theory] is the rule, and compliance the exception, at least on the deepest forex markets, the dollar-yen and the dollar euro market (cp. Priewe 2016). Periods of deviation are often long. This need not imply that Purchasing Power Parity is a false theory per se – it could be a sensible target, but floating exchange rates are driven by other factors.
Interest Rate Parity (which is what DMS are talking about in SimpleGift's post) is another theory but it also has empirical issues, isn't universally accepted, and has competitors. Other competitors include things like a general macroeconomic equilibrium equation taking into account employment and price levels, the Mundell-Fleming model (which takes into account, among other things, national output), behavioural expectations around future interest & exchange rates, capital flows, and more.

The economics textbook by Krugman, Obstfeld, and Melitz spends 225 pages on exchange rate theories so anyone who tries to tell you it is a simple subject with an open & shut answer is being misleading.
So, jumping back in after being away for a few days. Let me mount my modest defense of PPP.

So as you point out, lots of different exchange rate theories. It is like opening up a toolbox and finding both a hammer, a Allen wrench, and a dozen different other tools. It is not chaos and there is no reason to make a mountain out of a mole hill. We just need to find the right tool for the job, and recognize its power and limitations.

What is a good model? 2 points are simplicity and explanatory power.

PPP is simple to understand. The Economist's Big Mac index does it in a page. For Bogleheads I think this is the right level of complexity. If you want to engage in a discussion on a alternative theory I would be up for that.

It does have good explanatory power. As you stated it does a poor job of predicting short and medium term outcomes. Fortunately we don't care about those. This thread is on equities and we hold equities for the long term. Are currencies bounded and mean reverting? The longer the time frame we use the more true this is. If we look at 10 year periods currency risk fades into the statically background.

It is not the be all and end all of all theories. There are exceptions. USD remains consistently high, thanks to its reserve currency standard. It is interesting watching the EUR trying to blow itself up. Here we are going to need to pick up other tools to dig deeper, but I think the marginal benefit is low.

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Re: International Stock and Currency Issues

Post by AlohaJoe » Tue May 01, 2018 8:01 pm

alex_686 wrote:
Tue May 01, 2018 2:06 pm
PPP is simple to understand. The Economist's Big Mac index does it in a page. For Bogleheads I think this is the right level of complexity. If you want to engage in a discussion on a alternative theory I would be up for that.
The Big Mac index is a great example of the problems with PPP, not an example of how it succeeds. Prices of the Big Mac index have regularly exceeded +/-50% of PPP and deviations have usually lasted 20+ years without reverting. The Federal Reserve of St Louis (if I'm remembering right) has a paper on it.

One thing the Big Mac index highlights is that you can't talk in terms of pure tradeables because that's not a real world construct. At the very least you probably need to take the Harrod-Balssa-Samuelson effect - that the productivity of the non-tradeable parts of the economy matter - into account but that isn't perfect either because empirically it didn't seem to apply for large parts of the 20th century.

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Re: International Stock and Currency Issues

Post by alex_686 » Tue May 01, 2018 8:26 pm

AlohaJoe wrote:
Tue May 01, 2018 8:01 pm
The Big Mac index is a great example of the problems with PPP, not an example of how it succeeds. Prices of the Big Mac index have regularly exceeded +/-50% of PPP and deviations have usually lasted 20+ years without reverting. The Federal Reserve of St Louis (if I'm remembering right) has a paper on it.

One thing the Big Mac index highlights is that you can't talk in terms of pure tradeables because that's not a real world construct. At the very least you probably need to take the Harrod-Balssa-Samuelson effect - that the productivity of the non-tradeable parts of the economy matter - into account but that isn't perfect either because empirically it didn't seem to apply for large parts of the 20th century.
Thhe World Bank has the better data. There they try to bridge the difference that in rich countries the middle class buy dishwashers and vacuum cleaners and in poor countries your hire a maid. Here PPP drops to +/- 20% and tends to revert to normal within 10 years.

So it does have pure tradable items. PPP paints in broad strokes. Remover, it is simple and high level. It is not built for that level of detail. There could be structural issues - once again the USD reserve status. It might take 10 years to build a new factory in a depressed currency area. Etc.

FYI, and I have said this before, I would not bet on a currency where thhe PPP was out of whack. I donh't know what it will do next year. Probably some small movement, maybe large. However my holding period for stocks has a 10 year time horizon, at least.

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TinkerPDX
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Re: International Stock and Currency Issues

Post by TinkerPDX » Tue May 01, 2018 8:39 pm

Yes, but also possible to get excess return from the currency exchange rate, at least in a given year. But over time, we expect these to be a wash.

chatbotte
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Re: International Stock and Currency Issues

Post by chatbotte » Wed May 02, 2018 3:25 am

AlohaJoe wrote:
Tue May 01, 2018 8:01 pm
alex_686 wrote:
Tue May 01, 2018 2:06 pm
PPP is simple to understand. The Economist's Big Mac index does it in a page. For Bogleheads I think this is the right level of complexity. If you want to engage in a discussion on a alternative theory I would be up for that.
The Big Mac index is a great example of the problems with PPP, not an example of how it succeeds. Prices of the Big Mac index have regularly exceeded +/-50% of PPP and deviations have usually lasted 20+ years without reverting. The Federal Reserve of St Louis (if I'm remembering right) has a paper on it.

One thing the Big Mac index highlights is that you can't talk in terms of pure tradeables because that's not a real world construct. At the very least you probably need to take the Harrod-Balssa-Samuelson effect - that the productivity of the non-tradeable parts of the economy matter - into account but that isn't perfect either because empirically it didn't seem to apply for large parts of the 20th century.
AlohaJoe,

A persistent deviation from absolute PPP doesn't equate to currency loss though. If you invest half your money in VND stocks and the other half in AUD stocks for 20 years, and RER=3.5 at the start and at the end of the 20 years, you will have earned the same real return on that portfolio in VND or AUD.

pascalwager
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Re: International Stock and Currency Issues

Post by pascalwager » Wed May 02, 2018 11:04 pm

Lauretta wrote:
Mon Apr 30, 2018 3:42 am
pascalwager wrote:
Sun Apr 29, 2018 6:38 pm
Lauretta wrote:
Sun Apr 29, 2018 2:45 pm
pascalwager wrote:
Sun Apr 29, 2018 2:36 pm
nisiprius wrote:
Fri Apr 27, 2018 5:18 pm
I personally think a lot of international advocates don't "get" it that uncompensated extra risk is bad even if it is bidirectional.
My understanding is that currency risk applies in the short-term, but not the long-term. In the long-term, currency fluctuations balance out to nothing, so risk compensation is not needed. We're warned not to hold stocks for the short-term and I guess this doubles for int'l stocks.
yes but still it seems to me that if you invest a lump sum now in a stock market whose currency is significantly overvalued (as judged by PPP), say the Swiss stock market, the mean reversion argument suggests that over the long haul the swiss franc will probably be significantly devalued to get back to some value around the mean, so that you are likely to suffer because of this, even if you have a long term horizon
https://www.economist.com/content/big-mac-index
Long-term, the Swiss Franc may once again be overvalued. Also, the Swiss market is only 2.4% of the world market, and country diversification is desirable. Using BH siamond's global/domestic portfolio (75% world/25% domestic), an Italian or U.S. investor would only hold 1.8% Swiss market. His study considered currency dynamics and produced improved results compared to an Italian investor holding 100% domestic.
thanks for the feedback. The Swiss franc was just an example of course. The USD was another case that was overvalued relative to my currency (the Euro) when I invested a lump sum over a yr ago. I didn't hedge and since then the dollar has lost ~10% relative to the Euro (and according to PPP it' still overvalued). Luckily I have much less stocks in the US than I would have if I used a global market cap weighted allocation, otherwise half of my stocks would have suffered from this high devaluation of the USD. Having ~50% of one's stocks allocation in stocks denominated in a foreign currency (which is what happens if a non US investor (say from Italy like myself) allocates according to the weights of MSCI world) seems to me to produce a portfolio too vulnerable to the EUR/USD fluctuations.
Yes I will look at the study you mention (do you have a link?), what you say about en Italian investor historically does make sense since the lira (before the euro) was continuously devalued.
This is Part 3 of the study by siamond. You can also access the first two parts in Part 3.

https://finpage.blog/2017/03/25/investi ... ld-part-3/

Using his 75/25 example, you would currently have approx. 26% Italian stocks and 39% U.S. stocks. If you went with a 50/50 portfolio, then 51% Italian and 26% U.S. But of course, future global percentages may be different.

A U.S. investor might well go with global percentages--that's what I do and it leaves me with 52% U.S. But this is less than ideal, of course, for most other countries where the global domestic percentage is 2 or 3%.

Siamond is trying to provide a sense of the investing perspective in other countries, assuming we might someday find ourselves in similar circumstances.

zeugmite
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Re: International Stock and Currency Issues

Post by zeugmite » Fri Jul 13, 2018 3:47 pm

SimpleGift wrote:
Fri Apr 27, 2018 6:37 pm
alex_686 wrote:
Fri Apr 27, 2018 5:09 pm
Currency risk is bounded by Purchasing Power Parity (PPP) and thus mean reverting.
Due to the mean reverting tendencies of Purchasing Power Parity, Dimson, Marsh and Staunton have pointed out that, over the long haul, currencies essentially reflect relative inflation rates (chart below). For long-term investors who are concerned about the purchasing power of their investments, this creates an often overlooked benefit from the currency exposure of foreign equities.
In short, unhedged foreign currency exposure offers protection against unexpected inflation in one's own country.
Normally this is a good argument, but I truly think there is something asymmetrical about the $US market due to reserve currency status. As long as the status is retained there is dis-inflationary pressure in the US. Somebody with better insight could probably work out whether that contributed to the underperformance of ex-US markets post 2008 because funding and liquidity issues always seem a headline away.

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