For years, it was the money-minting trade for the investor set in London and Paris and Tokyo: Buy dollars and plow the proceeds into S&P 500 and Nasdaq stocks. Not only were US equity returns far superior to those generated at home, but they were magnified by the steady rise in the value of the dollar.
So when both parts of the trade suddenly blew up after President Donald Trump launched his global trade war, the pain mounted quickly. A 6% decline in the S&P 500 this year ballooned into a 14% wipeout for investors who measure their returns in euros and yen. The speed at which it has all unraveled, along with the constant zig-zagging from the White House, is unnerving investors who had counted on the US to be the ultimate safe haven and generator of outsized returns.
“It’s a double whammy,” said Benoit Peloille, chief investment officer at Natixis Wealth Management in Paris. “You lose on the equity and the currency at the same time.”
Even if Trump were to keep backpedaling and concede on the trade wars, the sheer chaos of the past month has exposed for many foreign investors the risks that come with funneling so much of their money into dollars. Many of them are rushing now to add currency hedges to an American equity portfolio that stood at some $18 trillion as of December, equal to nearly a fifth of all US stocks.
Both Morgan Stanley and Bank of America Corp. say they’re seeing more clients buy protection against dollar declines. And at Group Richelieu in Paris, Alexandre Hezez says his funds are now hedged to the maximum level allowed because “everything has been turned upside down.”
Hezez, like many investors, previously felt it made little sense to offset the foreign exchange risk. The thinking was that if US stocks sold off because of a global panic, the dollar would likely strengthen on haven demand and offset those losses. Overall currency hedging by foreign investors in US stocks stands at 23%, well below the near 50% level seen in 2020, State Street Corp.’s custodial data shows.
In one theoretical example, Bank of America strategists estimated that if investors were to return to pre-pandemic levels of hedging, that could mean covering an extra $5 trillion of foreign US equity exposure. Over at J.P. Morgan Private Bank, Global Head of FX Strategy Sam Zief said he’s fielding more requests from clients seeking advice on the topic than he’s seen in a long time.
Traders worried about foreign exchange declines typically sell the dollar in a forward market. To Swiss franc- or yen-based investors, the three-month hedging cost is about 4% on an annualized basis, and above 2% for those in euro. The upshot is being able to cancel out any dollar declines, but it also means losing out on any currency gains and the rolling cost can erode returns.
“For managers who took the plunge at higher exchange rates, each downward tick in dollar-yen can feel like salt rubbed into an open wound,” said Shoki Omori, chief desk strategist at Mizuho Securities Co. in Tokyo. “Skipping a hedge can invite sleepless nights.”
Options are another popular strategy, and trading in euro-dollar contracts is setting fresh records, according to US clearinghouse data. But more volatility means more expensive hedges. In the case of euro investors, it’s 15% more costly since the start of the year.
Fares Hendi at Prevoir Asset Management is one of the stock pickers that says it’s not worth trying to guess the next move in the dollar. His fund, which reaped big gains when US stocks were booming, paid a heavy price in the selloff. It’s plunged about 18% this year.
“Currency swings are something we just can’t predict,” he said from Paris. “Trump doesn’t know, Powell doesn’t know, nobody knows how it will turn out.”
Others caution against reading too much into a few weeks worth of trading. The US still boasts the world’s most liquid markets and profitable companies, with Alphabet Inc. reporting close to $80 billion in first-quarter revenue. The dollar is around a two-year low, hardly any evidence of a collapse.
The big question remains — Is this the beginning of a gradual withdrawal by international investors from American markets? In the view of Allianz SE, there’s nowhere else for all that money to go. But there’s so much invested in the US, some $28 trillion in international investment balances they estimate, that small shifts can have a big impact.
“If even a fraction of these assets were leaving the US, it would lead to even larger distortions in exchange rates and global asset prices,” wrote Allianz economists including Ludovic Subran in a report.
Plenty of strategists say euro strength and dollar weakness will last for years. Deutsche Bank AG’s George Saravelos wrote that the era of US exceptionalism has “already started to erode.” He sees the euro climbing to $1.30 by the end of 2027, a level that hasn’t been seen in a decade. At Danske Bank A/S, currency analyst Kirstine Kundby-Nielsen argues Europe is becoming a more viable option for investors and predicts the euro will hit $1.22 in the next 12 months.
Group Richelieu’s Hezez isn’t taking any chances. He started building a hedge ahead of Trump’s so-called Liberation Day on April 2, when the euro was trading around $1.05. It’s since surged through $1.15.
“My currency hedges have covered some of the losses suffered on the US stock market,” he said. “I plan to stick to this strategy in the short term, even if I think that in the long run it’s usually counterproductive.”
Written by: Alice Gledhill, Julien Ponthus, and Masaki Kondo — With assistance from Winnie Hsu, Naomi Tajitsu, Hideyuki Sano, Vassilis Karamanis, and Michael Msika @Bloomberg
The post “Unhedged and Burned, Stock Investors Brace for More Dollar Pain” first appeared on Bloomberg