International Trading and Currency Risks

A reader wanted to know the name of the broker that I use to buy securities on the Toronto exchange. I use Fidelity, but some other online brokers have this service also. More information about international trading at Fidelity can be found at Fidelity Investments.

I have limited my purchases to securities trading on the Toronto exchange so far. The commission is $19 Canadian. The symbols used for trading are different than the ones that I have referenced in previous posts which originate from Yahoo Finance. At Fidelity, the symbol for the Claymore ETF for 1-5 year Canadian Government bonds is CLF:CA. I have bought 400 shares of that ETF with part of my Canadian dollar position. BOUGHT 200 CLF:TO AT 20.20 CAD Added 100 CLF:TO-Sold 100 CPD:TO Sold HSE:TO at 30.48 CAD/Bought 100 of ETF CLF:TO at 20.10 CAD

I also own the Claymore ETF for 1-5 Year Canadian Corporate Bonds, and the Fidelity symbol is CBO:CA (CBO.TO at YF). Bought 100 CBO:TO at 20.4 & 100 CPD:TO at 16.09 By buying these and other securities on the Toronto exchange, I receive my dividend payments in Canadian dollars after a 15% withholding tax. This tax is paid irrespective of whether I buy the security on the Toronto exchange or the ADR on a U.S. exchange using U.S. dollars. If I buy the ADR using USD, I will receive the dividends paid in Canadian dollars in USDs after a conversion at the then prevailing exchange rate. Since I am a long term holder of CADs, capable of holding them for as long as I live, I prefer to receive the dividends in CADs to increase my position in this currency over time.

I am exposed to currency risk irrespective of whether I buy the ADR or the original shares on the Canadian market. I do not believe that most individuals understand the currency risk issue when they buy non-hedged international stock or bond funds, or individual foreign stocks and bonds. I do not avoid that risk by buying NYSE listed ADRs.

In several prior posts, I show how the ADRs track the share price of the original shares in the main foreign exchange for the company. I used several examples, including ADRs for companies based in France, Switzerland and Australia. Bought 100 AXAHY at 14.69 (EURO) ADDED 50 NABZY AT 19.51 (National Australia Bank (AUSTRALIAN DOLLAR); Added 70 RHHBY at 34.07-Completing Round Lot/ Swiss Franc-Euro (SWISS FRANC); Bought 100 NVS at 49.08 (SWISS FRANC); see also, Strong U.S. Dollar + Weak Market=Time to Start Looking Overseas).

I recently bought an ADR for Manulife (MFC). Bought 100 MFC at $15.05 I could have bought shares on the Toronto exchange, but elected to buy the ADR. I wanted to use my CADs to buy more of the Canadian Government bond ETF. I will receive dividends for MFC in U.S. dollars after conversion from the Canadian currency and the 15% reduction for the Canadian tax. (I let TurboTax deal with the foreign tax credit issue). But the price of my ADR shares will be linked to the ordinary share price in Toronto adjusted for currency exchange.

I wanted to highlight the currency issue for MFC which I did not discuss when I purchased shares. To do this comparison, I will take the price of MFC at a time when the Canadian dollar was weak compared to the USD. I pulled up a long term Chart of FXC, the currency ETF of the Canadian Dollar, and I see some weakness on 3/2/2009. I then pulled up a chart on the ADR MFC and found a USD price of $7.49 Chart The price close Friday at $15.31 for a gain of about 104%. The Canadian shares closed 3/2/09 at 9.65, MFC.TO, and at 15.8 last Friday for a gain of almost 64%. The difference between the ADR and ordinary share appreciation, which is very large, is the currency exchange factor, as the CAD has rallied against the USD since 3/2/09. The Canadian dollar will buy $.9674 on 7/9/2010, whereas it would buy only $ .7769 on 3/2/2009: CAD/USD Chart Until an investor understands the currency risk completely, they are unable to evaluate the risk and whether or not they want to assume it.

Now, I could have reached the same result as buying the ADR MFC by converting my USDs into Canadian dollars when the USD was strong on 3/2/09 and then buying MFC on the Toronto exchange. Then if I sold those ordinary shares, and converted the proceeds back into USDs, I would have received the same appreciation on the shares as the Canadian buyer on the Toronto exchange plus the currency appreciation of the CAD vs. the USD, minus the fees for converting both ways which would eat into the overall return some. Those fees are one reason to keep my CADs in Canadian dollars and to take my dividends and interest payments from Canadian securities in Canadian dollars.

Possibly, I would consider converting them back when and if 1 CAD would buy $1.25 USD. Otherwise, I am satisfied in trying to earn some kind of return on my long term CAD position.

For many individual investors, purchase of the ADR will be a satisfactory option for foreign stock exposure. I recently bought ADRs for Roche, Novartis, and Sanofi. A large institutional investor wanting to buy Roche shares would most likely look to acquire those shares in Zurich due to liquidity considerations. The Roche ADRs trade on the pink sheet exchange in the U.S. with relatively low volume. RHHBY Roche Holding Ltd: Also I do not believe Zurich is one of the 8 foreign exchanges where I can place trades. Otherwise, I would consider buying Swiss Francs to make purchases in Switzerland. I am more willing to accept currency risk from owning shares priced in Swiss Francs, Australian Dollars, Norwegian Krone, and Canadian Dollars, than any other developed market currency. But, I am not going to overdue it anywhere outside the U.S. due to currency risk considerations among other reasons. Most of my assets (90+%) are in USDs. I just do not want 100% in USD.

One reason that I bought the Claymore Canadian ETFs on the Toronto exchange is the transparency, volume and the low bid/ask spread. When I bought the shares of CLF:TO (CLF:CA at Fidelity) on Friday, the bid was 20.19 and the ask was 20.21. I placed a limit order to buy 200 at 20.20 which was immediately filled. My alternative was to purchase this security on the U.S. Grey Market using USDs. I would assume that any U.S. based broker allows for trades to be placed on the pink sheet market in its various forms: OTC Market Tiers, OTCQX, Pink Quote/OTCBB, OTCBB, Pink Sheets, Grey Market, Caveat Emptor

I prefer to avoid the Grey Market unless I want to buy a security and have no other choice. There is no transparency. There is either no volume or immaterial volume on most of the securities traded in the Grey Market. The bid/ask is not even displayed. There are no market makers, and no rules to speak of as far as I can tell. Forget about best order execution in the Grey Market. I have seen buy orders for a security filled at $15.5 when I was trying to buy at $16 and was not filled. Limit orders are therefore essential, and I would have to convert the Canadian price into U.S. dollars to even have an idea of where to place my limit order.

For example, CLF:TO closed Friday at 20.21: CLF.TO: Summary for CLAYMORE 1-5 YR LADDER GOV T BONDS. The Grey Market price for this security was $19.3341 with the last trade on 7/6/2010: CLFMF Claymore 1-5 Year Laddered Government Bond ETF: Summary As of 7/6/2010, the equivalent price in CADS would be around 20.40 CAD for $19.33 USD. Currency Converter

I would have to do a different calculation to know where to place my limit price for CLFMF on Monday. I would have to take the exchange rate at the time of my bid using the current share price information of the shares traded in Toronto. On Sunday, 7/11, using the closing prices of the shares on Friday of 20.21 CAD, and the current exchange rate, the equivalent price would be $19.58 USD. Currency Converter This will change on Monday some as the price of the Toronto shares change as well as the conversion rate. But after doing all of that work, and doing it right, I will most likely not receive a fill of an order in the U.S. Grey Market. So, most of the time, I do not bother with it.

For the shares that I have purchased on the Toronto exchange, Fidelity will show me the value in both Canadian dollars and U.S. dollars. The Canadian dollar price is from the Toronto exchange. It would not be unusual to see a fall in price in Canadian currency and a rise in the USD value or vice versa. This is a real time lesson in currency risk that an owner of the ADR will not see until they put pen to paper and do the calculations. The risk is still there for the ADR but is not graphically displayed in the same manner.

Strong U.S. Dollar + Weak Market=Time to Start Looking Overseas/Over-Reliance on Current 10 Year Average of S & P 500 Earnings/India GDP

Early this morning, markets are continuing to take their cue from Europe and particularly the declining EURO. The EURO fell this morning to a four year low, hovering around $1.21. MarketWatch The Dollar Index US (DXY) continues its march to 90 rising to the mid 87 level in early trading this morning. The DXY is heavily weighted in the Euro and bottomed on 11/25/2009 at 74.27 when the EURO hit its maximum level of strength against the USD.DXY Index Charts - (NASDAQ) US Dollar Index Future (a rise in the DXY indicates the USD is gaining in value against a basket of six currencies)

The ECB did not give sentiment an uplift by predicting that European banks would need to write-down 239 billion dollars in loans in 2010-2011. There was a report in a Spanish newspaper that the second largest savings bank, Caja Madrid, was requesting aid from the government.

Hewlett-Packard announced today that it plans to eliminate 9,000 jobs over several years as it plans to to spend 1 billion to automate its commercial data centers.

1. Buying Foreign Assets-Waiting for a Strong Currency and Weak Asset Price In Local Currency: Back in the late 1970s and 1980s, many in the U.S. were concerned about Japanese individuals and companies buying up U.S. assets. Back in those days, a dollar would buy over 200 YEN and as much as 300 Yen in 1974-1975. Between 1980 to 1985, the dollar would generally buy 200 to 250 YEN. (see table at the end of Japanese yen) The dollar was the strong currency. Now, a dollar will buy about 91 YEN. The Yen is the strong currency relative to the USD. On March 9, 2009, the dollar was buying about 99 Yen.

Now, if I was sitting in Japan waiting for an opportunity to buy U.S. assets, I would wait for the confluence of two events, and I would be patient. I would wait for my currency, the Yen, to be strong against the USD and for the U.S. assets to fall significantly in value. Then, assuming I could find assets worth owning, that would be the time to pounce. I would not want to buy U.S. assets when a dollar would buy 250 YEN. I want to use a strong currency to buy assets priced in a weaker one that have fallen a lot in value in local currency terms. This would have been the case for the Japanese investor in March 2009.

While major buying opportunities will not come along frequently, there will be a number of times when it would make sense for a U.S. investor to prepare a shopping list of foreign companies to own. Europe is one area that is becoming more interesting by the day due to the significant decline in the EURO and a correction in European stocks occurring at the same time. Australia would be another market. I just bought some shares in National Australia Bank whose shares had declined 32.76% from an October 2009 price for a U.S. investor, and 25.9% in local currency terms: ADDED 50 NABZY AT 19.51 (National Australia Bank) I have just started to analyse how much certain European companies have fallen in value in USD terms and their declines in local currency terms. Since around November 25, 2009, the Euro has declined about 18.5% against the USD.

Take a stock like Heineken. It is available for purchase on the pink sheet exchange: Heineken N.V. - HINKY The close was 23.92 on 11/25/2009 and $21.45 last Friday. HEINEKEN NV ADR Share Price Chart What does that tell me? It tells me Heineken has been rising in local currency terms during the period of the Euros major decline. So, I can scratch Heineken off this particular list, at least for those companies where I am looking for both a significant loss on the local exchange due to the stock market correction and a decline in value to me as a U.S. investor due to the more favorable currency exchange. I checked one of the European quotes, and found that Heineken had risen in value during the period of maximum loss for the Euro (since 11/25/09). HEINEKEN Share Price Chart | HEIA.AS My interest in Heineken would perk up when and if the shares and the EURO hit an air pocket at the same time. That started to occur to a minor degree in May.

A different situation is presented by Sanofi (SNY), which closed last Friday at $29.91, down from $39.5 on 11/25/09, a 24.3% decline. The decline on the Paris exchange was around 6.13%: SANOFI-AVENTIS Share Price Chart | SAN.PA This is not an argument to buy SNY, but simply points out that the down price action in the U.S. market is mostly currency related. If the Euro continues to sink against the USD, it would pay for me to wait to buy SNY. I do not know what the future will bring however. I do know that, if I bought SNY at Friday's close, it would be almost 19% cheaper to me than a purchaser on 11/25/2009 just on the currency exchange factor. For now I am more willing to play this angle with the AUD than the EURO.

Barrons has a different twist on the weakness in the EURO, suggesting in an article this week that investors focus their attention on large European companies that have substantial revenues outside the Eurozone. This involves the same logic as buying a U.S. multinational during periods of prolonged dollar weakness. I have some interest in some of the 10 stocks recommended in this article. Siemens (SI), one of the ten, might be an alternative to me for GE at some point, since I reached my tolerance level for management's ineptitude about 18 months ago. Siemens has risen about 8% on a German exchange since 11/25/2009, whereas the ADRs (SI) have fallen about 11.4% since then. SIEMENS Share Price Chart | SI

2. Brett Arends Column in the WSJ.com: Arends argues that the recent decline may be a harbinger of things to come. When there is a fast fall in the market, the technical indicators will look bad. Arends quotes John Hussman who maintains that his technical indicators had been this bad only 19 times before and the market on average fell 20% over the next 12 months. Arends asserts, without citing any sources, that the market may be as much as 50% overvalued when comparing shares prices to asset costs or normalized earnings. I have not seen any estimates that support that statement. Goldman Sachs recently raised its 2010 forecast for the S & P 500 earnings to $78 and its 2011 forecast to $93. At $93 and an index value as of Friday's close at 1089 (^GSPC), this would put the forward multiple at 11.71, which does not seem 50% overvalued to me.

If Arends is referring to the inflation adjusted monthly average daily closing prices divided by the 10 year average of real S & P earnings (P/E 10), then the market is overvalued since the historic average is around 16.3. A good discussion can be found at dshort.com: Is the Stock Market Cheap? I would note something that is frequently not admitted by those who will use a P/E 10 number to justify their predisposition to bearishness. The past 10 years includes two deep recessions. In another two years, there will only be one recession included in the 10 years of earnings data. And, assuming a mild to robust recovery in earnings, the normalized earnings for a ten year period will look a lot different in 2013 than it does now in 2010.

Looking at the chart in dshort's article linked above, the clear sell signals in history were when the P/E 10 hit 32.5 in 1929 and 44.2 in 1999. In retrospect, the 25.1 P/E 10 in the early 1900s and the 24.1 hit in the mid 1960s would have been good times to get out of Dodge and then to come back when the P/E 10 number hit the mid-to-high single digits. The article is dated in early May before most of the recent drop in the market averages started to occur. The P/E 10 number was 21.9 at the end of April, which probably added some fuel to the downdraft in May 2010.

The chart in dshort's article is the same kind of chart that was published in the NYT in March 2009, which made an impression on me at the time and actually buttressed my decision to buy stocks then. These charts also reinforce the need to sell parabolic rises such as the rise in 1999. Cramer Discusses Parabolic Rises/My Prior Discussions of Selling into Parabolas

Anyone who uses the P/E 10 number coming out of a recession may be attempting to justify a pessimistic outlook without undertaking a more thoughtful examination of the limitations of a blind adherence to a number without taking into account the entire context. David Rosenberg, who is currently forecasting 850 on the S & P, is a good example, as shown in his use of PE 10 in one of his recent missives (reprinted at ritholz.com) The fact that the P/E 10 number might be abnormally low now due to its inclusion of two deep recessions, including the one that has hopefully just ended, is an obvious point.

Notwithstanding the importance of this context, and context is invariably important, Professsor Shiller was insisting in February 2009 that the P/E 10 fall into the single digits before he could recommend stocks. Interview 2/23/2009 Shiller Stocks Not Yet Cheap Enough for Me: Tech Ticker The P/E 10 was then at about 14, impacted by two serious recessions being factored into the ten year earnings numbers. It is also important to take into account that the recent recession was not a normal one. The loss in the S & P 500 in the 4th quarter of 2008 was a record. The P/E 10 treats this type of event as something to be reasonably anticipated in every 10 year cycle even though it is more likely than not a once in a lifetime event And several large losses by financial companies and former S & P companies like Freddie Mac will distort a true picture of corporate America's profitability until 2018 for anyone placing undue emphasis on P/E 10.

Lastly, the stock market is forward looking and anyone who places undue reliance on the past will be missing major bull cycles on a continuous basis. Still, when the P/E 10 reaches 25 during a major secular bull market, it is time in my opinion to turn cautious. I am less concerned about a 20 reading after two recessions during the 10 year period, particularly a reading taken in a possible transition period to a multi-year up cycle in corporate earnings coming out of a once in a lifetime Near Depression.

At 1050 on the S & P 500, the P/E 10 is around 19.1.

Another doomsday use of P/E 10 can be found in Paul Farrell's column in MarketWatch from last Tuesday.

Dshort.com also has an interesting discussion of long term secular bull and bear markets, a frequent topic of discussion in this blog. I would use different dates to mark the beginning and end of the long term bull and and bear patterns.

3. India's GDP: India's GDP expanded 8.6% in the 1st quarter of 2010. India's government increased the GDP numbers for the 3rd and 4th quarters of 2009 to 7.9% and 6.5% respectively. Inflation is running hot at close to 10% in the first quarter.