Buy US dollar exposure

I can’t emphasise enough my bullishness on the US dollar.

In an investing world that arguably has more bubbles than value, the Greenback is blatant value. In fact, the US dollar, volatility and Chinese equities might just be the three cheapest ‘asset classes’ on the planet.

This morning, after further, broad-based US dollar gains last week (driven by strong US data), I am simply going to again update my macro strategy.

You need more of these either physically or indirectly by holding Australian listed stocks with a high proportion of US dollar revenue.

The multi-year US dollar “rights issue”, known as Quantitative Easing (QE), is coming to an end. At the same time, US cash rates will rise ahead of all global cash rates, from a very low base. The end of QE and zero interest rate policy (ZIRP) means the return of the US dollar as the world’s reserve currency and the end of short US dollar carry trades.

In favour of the US dollar

I have been titling our macro and portfolio strategy in favour of the US dollar since early 2013, via a short Aussie dollar overlay. But today, as the ASX200 goes ex FY14 final dividends and focus moves to the Fed, I think there’s more urgency required. The majority of Australian investors are too nonchalant about the portfolio ramifications of a recovering US dollar.

I am sure most Australian based investors are very happy with the capital growth and dividends/franking credits they have received, but it’s time for a bit of a global reality check.

The benchmark ASX200 in US dollars has broadly gone sideways for four years (1 Jan 2011 to today). You have underperformed via being solely exposed to Australian assets and your global purchasing power has been reduced.

Click here for larger image

You have done significantly better than the domestic market via holding the ASX200 Banks Index in US dollars (+40%), but even that peaked in US dollars terms in April 2013 and has tracked sideways to lower since.

Click here for larger image

Conscious home bias

I am fully aware that the Australian taxation and superannuation system currently, and I stress currently, drives significant home bias towards negative gearing and Australian fully franked assets, particularly when overlaid with an ageing population and record low cash rates, but if I am right about the medium-term outlook for the US dollar and US interest rates, the underperformance of Australian “yield” assets in US dollars will accelerate.

This comes at a time when Australians have never been more exposed to those yield assets (masquerading as fixed interest) in Australian dollars. Australians effectively have a tax driven yield carry trade on in a carry trade currency. That equates to an exposure to global macro variables changing, taxation treatment changing, and a double exposure to record residential property prices via domestic mortgage banks.

Here is a series of US dollar charts that all point in one direction since FOMC chair Janet Yellen gave a firm date for QE ending (October).

US Dollar Index (DXY)

Euro per USD

Japanese Yen per USD

Australian Dollars per USD

It’s also worth noting that the US dollar is also recovering vs. spot gold. This is the 10-year chart of spot gold in US dollars, with the uptrend being challenged. Spot gold is down 36% from its peak.

The resurrection

This US dollar resurgence has started. You can see above it’s against everything. Markets start moving ahead of “the fact” and that is what we are starting to see and why I am stepping up the aggression both top down and via bottom up stock picking to this twin macro theme of the recovering US dollar and rising US cash rates.

Some readers have been a little surprised I have recently recommended/up weighted BHP Billiton, Fortescue Metals Group, BC Iron, Whitehaven Coal, Sims Metal Mgt, and Iluka when underling US dollar commodity prices are still a touch wobbly. That strategy is two pronged. I believe the underlying commodity price, but particularly spot iron ore, will stop falling shortly and be replaced by a significant Aussie dollar/US dollar fall that will actually see Aussie dollar commodity prices rise (good for those with low cost production growth). It’s a view based on both the numerator and denominator of the Aussie dollar commodity price equation. Let me just emphasise by overlaying spot iron ore prices in US dollars with the Australian Dollar in US dollars. A re-correlation would see the Aussie dollar at 87 US cents.

Iron ore vs. AUD/USD

The king’s Crown

Similarly, some readers ask me why I am going so hard on Crown Resorts (CWN). Again it’s a twofold approach. Crown benefits from Australia becoming more globally competitive as a tourism destination, while simultaneously Melco Crown Entertainment’s US dollar earnings, dividend and valuation stream is worth more to ASX/Aussie dollar listed Crown on translation. It’s worth reminding yourself of the correlation between Crown and the Australian dollars per US dollar chart.

CWN vs. AUD per USD

For many, many years in these notes I told you “DON’T FIGHT THE FED”. That was good advice, and just about all our total return best ideas were beneficiaries of yield compression/PE expansion. However, you need to remember that advice works both ways and that is why, over the last few months, I have been recommending locking in the performance generated by that multi-year strategy, but particularly via moving underweight Australian banks.

On the other side of that strategy move, I have been increasing ASX-listed US dollar earner exposure almost every day since I have been back from holidays, including QBE, Westfield Corp, Servcorp and Qantas. That strategy will continue and I am using the reporting season to look for more leveraged ways of gaining ASX exposure to US dollars revenue streams. It’s all about driving in a different lane.

Better to be early than late

Obviously though, however, that is not the ideal strategy. It is a second derivative option for domestic investors. The ideal strategy is to physically get some of your investment capital into US dollars. I said this back in early 2013 at 106 US cents and I am saying it again today at 91.50 US cents. Remember, the Aussie dollar/US dollar cross was very resilient at 106, then cracked quickly. It all feels the same here to me for the last six months.

I also think that currency and interest rate volatility will lead to equity market volatility and I encourage you to hold some form of downside protection. I remain of the view the two best forms of protection are long VIX futures and holding US dollar cash.

It’s not usual for me to do this but I am going to finish today with a weblink to a 14-minute video presentation by Hamish Douglass, lead portfolio manager at Magellan Financial Group (MFG).

I agree with Douglass’s views, almost entirely, with the key point to remember it is better to be six months early in positioning, than six minutes late. That’s a very good line.

If you agree with my US-dollar strategy above, you could do a lot worse than invest in a reputable, unhedged, global equities absolute return fund for the years ahead.

Either way, you’re all holding too much exposure to Australian tax effective yield assets in Australian dollars. That is not going to be an outperforming strategy from here.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

100% of Charlie Aitken’s fees for writing for the Switzer Super Report are donated to The Sydney Children’s Hospital Foundation.