This article originally published in The Northern Daily Leader on 1 February 2014.
For a very numbers-oriented world, the language of the stock market is a colourful and evocative one. When the market is doing well, with shares rising strongly in value, we talk of the bulls taking control. Bullish investors, viewing the future through rose-tinted glasses, stampeding through the market, pushing up prices for any old rubbish higher and higher. The market surges, stocks bounce, indices catapult and investors wallow in their wealth. Seemingly overnight however, the bears chase out the bulls and take control of the market – prices crash, indices tumble, wealth is destroyed and markets collapse. All very dramatic for what is supposed to be simply an orderly and effective means of allocating capital.
The language of the market has also found its way to everyday life. We all know the expression to ‘hedge one’s bets’, which involves adopting an offsetting position to minimise your losses if your first ‘bet’ doesn’t pan out quite like you had hoped. The expression originally arose from the planting of an actual hedge around your land, thereby delimiting the extent of your ownership. Hedging plays an important role in investing, where it is used most frequently to hedge foreign currency exposure as part of international investing. This ensures that an increase in the value of your home currency relative to the currency of the country in which you are investing does not offset any capital growth achieved by your investment. Unfortunately, hedging offshore currency exposure is expensive, particularly when large sums of money are involved. As a consequence, many large institutional investors will adopt only a limited hedge of their currency exposure, hoping to repatriate their invested funds prior to any large-scale falls in the foreign currency. At the first sign of trouble, investment managers act swiftly to pull their money back home, avoiding potentially significant losses as the foreign currency depreciates in value.
This set of circumstances quite closely matches the current situation in global investment markets. US-based investors have made healthy returns investing overseas, helped by prolonged weakness in the US dollar. The general consensus is that the US dollar is on the way up, bad news for unhedged US investors. And as expected, these investors are not going to hang around and wait for the inevitable, so they are selling the assets they have carefully accumulated over the past five or six years. Emerging market debt, shares, currencies, commodities…just about every asset class is going to be impacted by this process, most particularly in countries such as Brazil, India, Indonesia and South Africa. The bears look set to take control, but how long before the bulls come back to chase them out?