Recessions Are Perfect for Currency Investing

by: Sean Hyman December 03, 2008 | about stocks: FXA / FXB / FXE / FXY    

Sean Hyman

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One thing that I love about the currency market is that there is always a currency or two going up at all times, even when stocks and commodities are getting thrashed.

The global slow down that has punished stocks for well over a year now has seemed to have “blessed” a couple of currencies out there. Some currencies can actually benefit from “hard times”.

Let’s take a look at the chart of the Japanese yen below since “a picture is worth a thousand words”. I’ve overlaid it on a chart of the S&P 500 so you can see how “inversely” they have tended to trade against each other (click to enlarge).

So why in the world could a currency actually rise in value, especially since Japan is in a recession just like Europe and the U.S.?

Well, it’s like this. In “tough times”, money wants to run away from assets that appear to be lofty or risky and run instead to assets that have been severely beaten down. That way, they may tend to either, not fall at all, or fall less than most other financial assets out there in the markets.

Two of the most “sold” assets in the “good times” were the U.S. dollar and the Japanese yen. You would see reports on the nightly news about how both were plunging as stocks and commodities were soaring.

As Stocks Perished, the Yen Flourished

However, now the exact reverse has been true. As stocks have plunged and money runs out of them…it has to go somewhere. So it searches out the most beaten down assets out of any financial market: stocks, commodities, currencies, etc. It just so happens that the currency market has had two of the “safest” looking assets since these two currencies have been sold off for three years back to back.

Therefore as money ran out of stocks and commodities it found a place to “hide” within the U.S. dollar and especially the Japanese yen. This switch in sentiment from a “risk seeking” to a “risk aversion” mode has really helped out these two currencies as they have served as “defensive plays” out there in the market…away from the storm.

Now, once the tide finally turns and a bottom is in place in the stock markets and commodities finally stabilize, you will see money pour out of these two assets and back into higher yielding currencies like the Euro, British pound, Australian or New Zealand dollars, etc.

So as you can see, there’s always a place to turn to within currencies no matter what the other markets look like. No other market can boast that they can benefit in “boom times” and in “bust times”.

Therefore, I’d encourage you to consider adding in currencies to your portfolio. As you can see, if you had owned the yen and the S&P 500, the yen would have smoothed out much of the volatility to your S&P 500 index fund.

While everyone else is “crying the blues”, you would still be holding up just fine.

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This article has 11 comments:

  •  
    Dec 03 11:00 AM
    This would have been much more useful if you'd published it last October.

    Here's another idea for an article: If stocks are about to crash, just sell them in advance. Then, while everyone else is “crying the blues”, you'll be holding up just fine.
    Reply | Link to Comment
  •  
    Dec 03 09:13 PM
    There is good research out there showing that in recessions (over the past few decades) you long the American dollar and short the Canadian (and Australian) dollar.
    True again this time.
    But maybe knowing when to reverse that position will be different this time.
    Reply | Link to Comment
  •  
    Dec 06 07:01 AM
    I don't see GBP as a higher yielding currency, we in the UK are headng to ZIRP. The Euro will likely follow. USD strength looks likely to continue as the depression intensifies.

    Reply | Link to Comment
  •  
    Dec 08 11:41 AM
    Now is not the time to long the USD, or the yen, unless you are trading intraday. Too many uncertainties at this point. Look to crosses related to commodities (like CAD, NZD and AUD) and hold through the cycles -- but don't look too closely at the price each day or you'll end up with ulcers. It isn't for the faint of heart.

    Equities are gonna be choppy -- market is currently running out of sellers, as it was last week, so shorts who aren't nimble will almost certainly get crushed. Likewise, buyers who get greedy will get crushed. This is a depreciatory situation for both the USD and yen. I suspect other currencies will grind higher as money moves out of these two.

    There is nothing easy about trading currencies. Hyman hits some good general points. But it's the specifics that kill ya. Too many to mention here. Agree that this article should have been written earlier...by more than a year, perhaps, when EVERYONE and their Auntie was publishing stuff just like this.

    I suspect that 90% of those who follow this guy's advice in the last paragraph will have wiped out their currency accounts by this time next year. Unless they have very deep pockets or trade in sizes so miniscule as to be not worth the effort. In short, his timing is waaaaay off. Risk in these two bets is too high at the moment.
    Reply | Link to Comment
  •  
    Dec 08 05:21 PM
    Remember, though...the inverse is true too. As stocks start to recover, the yen will likely tank very hard. As it does, if were short the yen, it could speed up the recovery of your stock portfolio. So it works both ways.


    On Dec 03 11:00 AM Calgary wrote:

    > This would have been much more useful if you'd published it last
    > October.
    >
    > Here's another idea for an article: If stocks are about to crash,
    > just sell them in advance. Then, while everyone else is “crying the
    > blues”, you'll be holding up just fine.
    >
    Reply | Link to Comment
  •  
    Dec 08 05:23 PM
    Stocks appear to be rallying lately on "bad news days" which is bullish and the "first signs of life" that we've seen in a while.

    Therefore, the party for the yen may be almost over. If so, when stocks for sure reverse to the upside (and that may be in the beginning stages now), then that could be a great time to look to reverse those positions ...as investors come out of the "risk adverse" (defensive plays) and back into stocks and higher yielding currencies.


    On Dec 03 09:13 PM Paulo wrote:

    > There is good research out there showing that in recessions (over
    > the past few decades) you long the American dollar and short the
    > Canadian (and Australian) dollar.
    > True again this time.
    > But maybe knowing when to reverse that position will be different
    > this time.
    Reply | Link to Comment
  •  
    Dec 08 05:25 PM
    It's amazing the USD, when everything started looking really bad everywhere it finally started getting stronger.
    Reply | Link to Comment
  •  
    Dec 08 05:26 PM
    The recession will likely end soon since the average recession lasts 8-12 months and we're already at the 12 month mark (here in the U.S.). Since the sell offs were so much faster in this recession, it's likely that in the coming weeks to months...the worst will finally be behind us. IF that's the case, then stocks will begin to flourish again and the dollar and yen (which flourished in the stock downturn) will likely fall against most all other major currencies.


    On Dec 06 07:01 AM Debt Junkie Scum wrote:

    > I don't see GBP as a higher yielding currency, we in the UK are headng
    > to ZIRP. The Euro will likely follow. USD strength looks likely
    > to continue as the depression intensifies.
    >
    Reply | Link to Comment
  •  
    Dec 08 05:29 PM
    Keep in mind that the currencies that went up when stocks went down...are likely to be the ones that go down once stocks head back upward. So people that think this is all hindsight aren't seeing that both sides are true. If investors think the yen will continue to rise with a rising stock market...they are kidding themselves. The yen heads lower when "times are good and stocks flourish"...and so has the dollar much of the time. Hope this helps.


    On Dec 08 11:41 AM LonelyTrader wrote:

    > Now is not the time to long the USD, or the yen, unless you are trading
    > intraday. Too many uncertainties at this point. Look to crosses related
    > to commodities (like CAD, NZD and AUD) and hold through the cycles
    > -- but don't look too closely at the price each day or you'll end
    > up with ulcers. It isn't for the faint of heart.
    >
    > Equities are gonna be choppy -- market is currently running out of
    > sellers, as it was last week, so shorts who aren't nimble will almost
    > certainly get crushed. Likewise, buyers who get greedy will get crushed.
    > This is a depreciatory situation for both the USD and yen. I suspect
    > other currencies will grind higher as money moves out of these two.

    >
    >
    > There is nothing easy about trading currencies. Hyman hits some good
    > general points. But it's the specifics that kill ya. Too many to
    > mention here. Agree that this article should have been written earlier...by
    > more than a year, perhaps, when EVERYONE and their Auntie was publishing
    > stuff just like this.
    >
    > I suspect that 90% of those who follow this guy's advice in the last
    > paragraph will have wiped out their currency accounts by this time
    > next year. Unless they have very deep pockets or trade in sizes so
    > miniscule as to be not worth the effort. In short, his timing is
    > waaaaay off. Risk in these two bets is too high at the moment.
    Reply | Link to Comment
  •  
    Dec 09 02:20 PM
    "but don't look too closely at the price each day or you'll end up with ulcers. It isn't for the faint of heart."

    I agree - The market is clearly far from normal. Normal theory must be thrown out the window as we could no longer be concerned about the potential for return but for a safehaven for our funds. Investing in the market now could be the key IF you are prepared and stomach it.


    On Dec 08 11:41 AM LonelyTrader wrote:

    > Now is not the time to long the USD, or the yen, unless you are trading
    > intraday. Too many uncertainties at this point. Look to crosses related
    > to commodities (like CAD, NZD and AUD) and hold through the cycles
    > -- but don't look too closely at the price each day or you'll end
    > up with ulcers. It isn't for the faint of heart.
    >
    > Equities are gonna be choppy -- market is currently running out of
    > sellers, as it was last week, so shorts who aren't nimble will almost
    > certainly get crushed. Likewise, buyers who get greedy will get crushed.
    > This is a depreciatory situation for both the USD and yen. I suspect
    > other currencies will grind higher as money moves out of these two.
    >
    >
    > There is nothing easy about trading currencies. Hyman hits some good
    > general points. But it's the specifics that kill ya. Too many to
    > mention here. Agree that this article should have been written earlier...by
    > more than a year, perhaps, when EVERYONE and their Auntie was publishing
    > stuff just like this.
    >
    > I suspect that 90% of those who follow this guy's advice in the last
    > paragraph will have wiped out their currency accounts by this time
    > next year. Unless they have very deep pockets or trade in sizes so
    > miniscule as to be not worth the effort. In short, his timing is
    > waaaaay off. Risk in these two bets is too high at the moment.
    Reply | Link to Comment
  •  
    Dec 17 04:28 PM
    Now that the Fed has lowered the U.S. rate to even lower than Japan's rate....expect the greenback to lose its luster and to become a "carry trade" funding currency for the euro, aussie, etc. in EUR/USD, AUD/USD, etc.


    Reply | Link to Comment
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