Robert Kavcic is vice-president and senior economist at BMO Nesbitt Burns Inc.
Canadians have been transfixed by the decline in the value of their dollar, which posted its second-worst year on record in 2015. The start of this year has provided no relief, with the currency dipping below 70 cents (U.S.) at one point this week for the first time in 13 years.
Financial markets have zeroed in on deteriorating fundamentals, including the relentless decline in oil prices, monetary policy divergence between the Bank of Canada and U.S. Federal Reserve Board and growing expectations that Ottawa's deficit will jump well above the $10-billion (Canadian) mark next fiscal year.
Rewind for a moment to the Great Recession, which decimated U.S. real estate values. With every crisis comes opportunity, and for Canadians, that opportunity was to snap up severely undervalued U.S. property. U.S. home prices fell more than 30 per cent between 2006 and 2009, or nearly 50 per cent in Canadian dollar terms, to the lowest levels in more than a decade.
By 2011, however, fundamentals were quickly improving. The foreclosure rate had peaked, the overhang of inventory on the market was starting to fall, mortgage lending standards were stabilizing and households were wrapping up a prolonged period of paying down debt. For Canadians eyeing these rapidly improving fundamentals south of the border, the case to act was made even more compelling by the Canadian dollar, which was trading above parity and well above its fundamental value versus the greenback at that time.
Fast-forward five short years, and those who made the move to buy property south of the border have been rewarded beyond even their most bullish expectations. The improving fundamentals that we saw back in 2011 indeed proved to be real, and U.S. home prices have since rebounded more than 30 per cent, with some choice markets on the West Coast and in the southeast posting even stronger gains. All the while, the Canadian dollar has plunged 30 per cent, effectively doubling the return earned by Canadian buyers and quickly lifting currency-adjusted prices back above their prerecession highs.
One valuable lesson here is that currency matters when making investment decisions – and it matters a lot. Consider another example of a Canadian investor faced with a typical stock-versus-bond allocation decision. Equity markets have struggled since the start of 2014, with the TSX down roughly 10 per cent and the S&P 500 scratching out a modest 5-per-cent gain. Government bonds have provided investors some shelter, with 10-year Treasuries returning a solid 13 per cent over that period.
That said, a typical balanced portfolio allocated 60 per cent to equities (split evenly between Canada and the United States) and 40 per cent to bonds (using 10-year Treasuries as a benchmark – Canada's have outperformed) would have returned less than 2 per cent annualized over the past two years. That has barely kept pace with inflation. However, by recognizing the potential weakness in the loonie and unhedging the U.S. equity portion of the portfolio, S&P 500 returns in Canadian dollars over that period balloon to 40 per cent. The impact of that small change on the overall portfolio is substantial, more than tripling the annualized return to about 7 per cent.
The sudden turnabout is a reminder to investors not to lose sight of the currency, and that once-in-a-generation buying opportunities can come and go in a flash.