Where the peso’s going and what to do
Letter from the President
The peso-dollar rate closed Friday 12 December at $1.00=MXN14.76. You’re probably wondering where might the exchange rate be going and how we’re handling the peso collapse in client accounts. We expect a near-term recovery. But you should not bet on that or any view in the derivatives markets unless you speculate on derivatives for a living. For peso-based clients bringing capital into the market, we’re currently buying Swiss, U.K. and non-Japan Asian equity.
Where is the exchange rate going?
First off, of course no one can know how exchange rates will behave. We can only offer well informed views. My view is that the dollar has overshot and will come down starting in the next few days, and that, over the next 12 months, the peso will recover to better than 13.50.
In October we took a wrong (volatile) turn
Starting in October the peso started to depreciate against the dollar. At first we thought this trend was transitory, so, for new capital added to existing accounts or for new accounts we’ve bought peso-denominated assets—mostly equity. We expected equity globally to continue rising on trend but did not want to buy the dollar at what we thought back then was expensive (US $1.00=MXN13.54). Our game plan was to wait for the peso to rebound, then close out the transitory bucket by reallocating its capital through our normal strategy: across a globally diversified, dollar-dominated group of exchange traded funds.
We’ll let you know when we close out these transitory buckets. We still think that the tack will prove profitable over periods exceeding two years but now of course now recognize that, in terms of short-run volatility, our tactic turned out to be an expensive one.
In December we corrected our tactics
We changed tactics in December. Wherever our investment mandates allow, for new pesos coming under our management, we’re set up transitory “buckets” (portfolios) allocated across Swiss, UK, and Asia ex-Japan equity. This means we’re betting on developed market equity as an asset class while avoiding the dollar (too expensive), the euro (expected to sink against the dollar on trend for the next 2-3 years), the yen (idem), and emerging market currencies (too risky right now), and minimizing exposure to the Australian and New Zealand dollars (linked to commodities, which are also plunging).
Note that the Swiss franc, UK pound, and Asian currencies have fallen against the dollar also recently. So, buying them was less pricey than buying dollar-denominated equity.
Our new tack is a bet that, over the next six months, the following scenario will play out in markets:
Stage One. Equity recovers. Because we’re holding it, we ride on its recovery.
Stage Two. Non-euro, non-yen, non-commodity developed market currencies recover against the dollar. Because we’re holding them, we ride on this recovery too. Once the recovery complete, we spread the capital back out per our normal strategies.
Stage Three. Emerging market currencies recover at least some against the dollar.
Our point is, with the dollar so expensive, to postpone buying today, with pesos, any dollar-denominated securities, but to go ahead and jump into equity.
Don’t speculate in derivatives unless that’s your full-time job
For clients caught short of dollars for business transactions, I give my view that the dollar has overshot and will come down starting in the next few days, but add that of course I really don’t know what will happen and I question whether my view is even relevant to their hedging decision.
Is it relevant to yours? It depends:
If you can’t afford to lose on exchange rates or can’t stomach uncertainty, it is not: you should hedge on derivatives markets regardless of my view.
If you can afford to lose and don’t mind uncertainty, you may decide to take my view into account. If you need dollars in the next few days, my view points to refraining from hedging. But it does not point to betting on my view in the derivatives market.
My point is that, unless you’re a professional speculative derivatives trader, you should use derivatives only to buy certainty (sell risk), never to speculate. Certainty has a two-part price: a certain transaction cost plus a possible loss relative to what would have happened had you stayed in the spot market. Hedge whenever that cost—the sum of its certain component and the risk of its uncertain component—is worth it to you.
Again, unless you’re a professional derivatives trader, use derivatives only to hedge risk you find intolerable or undesirable, never as a bet.
Previous Letters from the President
- 15 Dec 2014: “
itthe peso will recover to better than 13.50″.