Where's the Loonie Headed?

Where’s the Loonie Headed? Follow Fundamentals, Not Fluctuating Foreign Exchange

In response to falling oil prices, shifting interest rate policies and subdued inflation, the Canadian dollar (C$) has fallen 26% (compared to the U.S. dollar) from its 2011 high, a drop that was only surpassed by the 29% decline through the 1990s. Today, at roughly US$0.80, the loonie is at its lowest level since the financial crisis in early 2009, raising the questions: Where is the C$ headed now? • What does it mean? • What should investors do?

Summary Where is the C$ headed now?

• The Canadian dollar has depreci- While we don’t expect a rapid rebound, we think the bulk of the ated sharply versus the U.S. dollar, loonie’s drop has already happened. However, we could see the driven by falling oil prices, shifting loonie remain low or even fall further this year due to the following: interest rate policies and subdued • Low oil prices. The C$ and oil prices tend to move in the same inflation. direction. The 50%-plus decline in crude oil prices probably • We don’t expect a rapid rebound, won’t recover quickly, which suggests that oil may not help the but we think the bulk of the loonie in the near term. In our view, increased oil production in loonie’s drop has occurred. the U.S. and China’s slowing growth will limit the rebound in oil prices this year. • The falling loonie doesn’t foretell a falling market. Previous extended • More aggressive monetary policy. There’s a growing divide C$ declines were accompanied by between Bank of Canada (BoC) and U.S. Federal Reserve (Fed) stock market gains. interest rate policies. The BoC cut rates in January to counteract a softening housing market and falling oil prices. High consumer • Currency fluctuations affect debt levels and tepid job growth will probably keep domestic investment returns, but history economic growth at modest levels, so the BoC will stay “on the shows that the impact is relatively offensive” as far as monetary policy goes – we could see another small over the long term. rate cut this year if growth remains sluggish. At the same time, • Timely adjustments are prudent, the U.S. Fed is taking its foot off of the accelerator after years of but don’t make wholesale changes aggressive stimulus. This divergence in monetary policy actions or abandon diversification because could put Canadian and U.S. interest rates on different paths, of currency moves. which would limit any C$ appreciation.

• We recommend raising interna- • Subdued inflation.Inflation has averaged just 1.9% over the tional portfolio allocations, with past year.1 The most recent monthly reading was just 1% – well balance between the U.S. and over- below the BoC’s target. Falling energy costs, mediocre job seas investments. growth and modest wage increases suggest inflation will stay low. This should also keep a lid on domestic interest rates and the C$ in the near term. RES-9063-C MAR 2015 PAGE 2 OF 3 © 2015 EDWARD D. JONES & CO., L.P. ALL RIGHTS RESERVED.

What does it mean? It’s all relative. Remember, currencies don’t rise and fall in isolation. Here are a few key takeaways:

• The value of the Canadian dollar isn’t falling broadly across the globe – The loonie’s depreciation has occurred relative to the U.S. dollar, where economic growth is gaining momentum and interest rates will probably rise this year. Compared to other major currencies, the C$ has been much stronger. In fact, over the past year, the C$ was flat compared to the Japanese yen and has appreciated 6% versus the euro. In other words, this signals that the Canadian economy remains in relatively reasonable shape.

• There is a bright side to a lower loonie – Exports represent about 25% of Canada’s economy, and around three-quarters of those exports go to the U.S. The drop in the C$ makes Canadian exports cheaper for U.S. purchasers. Rising U.S. demand and falling prices in C$ could provide a much-needed boost to Canada’s economy. We’ve already seen evidence of this. Merchandise exports to the U.S. have gone up 7% over the past year and 16% since the loonie started descending from par in January 2013.

• Currencies are cyclical – The C$, like the stock market, won’t move in one direction forever. The recent divide between Canadian and U.S. economic growth and interest rates has spurred the loonie’s move from par to US$0.80, but the gap won’t widen indefinitely. While currencies can be prone to sizable or extended directional moves, shifting economic and policy conditions around the world will cause currencies to ebb and flow. These moves are often unpredictable, so we’d advise against speculating on the timing of currency fluctuations. As you can see from this chart, the drop in the C$ has simply brought it back to its 30-year average versus the U.S. dollar.

The C$ Is Near Its Long-term Average versus That of the US$ 1.1 US$ per 1 C$ 1

0.9

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0.7

0.6

’85 ’87 ’89 ’91 ’93 ’95 ’97 ’99 ’01 ’03 ’05 ’07 ’09 ’11 ’13 ’15 Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Source: Bloomberg.

• Falling Dollar Doesn't Mean Falling Markets. Markets Can Do Well amid a Rising and Falling Loonie The depreciating loonie doesn't mean disaster for Period of C$ Change in Annualized Performance the domestic stock market. In fact, the extended Rise/Fall C$ TSX S&P 500 drops in the C$ from 1976 to 1985 and from 1991 ’76-’85 -31% 11.2% 7.7% to 2002 were accompanied by solid stock market gains. Because the Canadian economy and the ’76-’85 +24% 2.8% 11.1% TSX index are more sensitive to commodity prices ’91-’02 -29% 8.4% 13.4% today, volatile oil prices may make domestic ’02-’07 +61% 13.4% 7.2% market performance a bit bumpier. But sustained ’09-’11 +31% 24.0% 27.7% GDP growth (albeit modest) and increasing corporate profits should influence the stock ’11-’15 -23% 6.7% 15.9% market more than the loonie. Source: Bloomberg, Edward Jones. As of 2/26/15. Performance in local currency. Past performance does not assure future results. RES-9063-C MAR 2015 PAGE 3 OF © 2015 EDWARD D. JONES & CO., L.P. ALL RIGHTS RESERVED.

What should investors do?

Adjust, Don't Abandon. Currency fluctuations affect investment returns, but history shows that the impact is relatively small over the long term. We believe timely portfolio adjustments to account for shifts in the landscape are wise, but we don't recommend making wholesale changes or abandoning certain asset classes or geographies because of short-term currency moves. We expect the loonie's value to rise and fall over time, with varying degrees of change relative to different currencies. We believe owning a broad mix of domestic and global investments will outweigh the swings in the C$.

Evaluate Your U.S. Expenses. The lower loonie has a tangible impact on our daily lives when making U.S. purchases. If you have regular living expenses in U.S. dollars, do cross-border shopping or are planning U.S. travel, you may need to budget for the exchange rate impact. Where appropriate, you may consider U.S. bonds with income to match recurring U.S. expenses. We don't expect an imminent sharp rebound in the loonie, and we don't believe the recent degree of depreciation will be repeated moving forward. Review your long-term savings goals and spending needs to ensure your investment strategy is aligned to achieve them.

Raise International Portfolio Allocations. Consider an international allocation for up to half of your stock portfolio, with balance between U.S. and overseas investments.

• Large-cap stocks look most attractive to us in the U.S. The appreciation in the U.S. dollar may make it feel like U.S. stocks are too expensive, but a broader perspective is warranted. We think the prospects for earnings and dividend growth, along with market valuation, should be the primary determinant in evaluating U.S. investments. Another strategy that may help reduce the impact of swings in the C$ is investing in mutual funds that offer currency hedging.

• And look outside North America too. Overseas developed-market large-cap stocks look particularly attractive in the current environment. The loonie's moves have been less dramatic compared to those of other global currencies, which gives Canadian investors a bit more purchasing power overseas. While challenges in Europe, Japan and China are unlikely to disappear in short order, international markets have the tailwinds of more aggressive monetary stimulus and more attractive valuations. We recommend raising underweight allocations to overseas developed markets (such as Europe and Japan) through quality, diversified global mutual funds and ETFs.

Talk with your Edward Jones advisor today about stock and mutual fund opportunities that may help balance your portfolio and address currency impacts.

Sources: 1. Bloomberg. Diversification does not assure a profit or protect against a loss. Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events. Investing involves risks. The value of your shares will fluctuate and you may lose principal.

Craig Fehr, CFA www.edwardjones.com Investment Strategist Member - Canadian Investor Protection Fund