Rising U.S. dollar ails investors here
Poses biggest risk to global markets
Canadian investors have not had a good year, as cash is likely to outperform both stocks and bonds for the first year since 1990.
The trade of the year, though, has been the U.S. dollar, which has skyrocketed nearly 17 per cent over the past 12 months against the loonie and other major currencies.
Investment managers lucky enough to hold a large position in U.S. dollars have been able to deliver positive results, while others not so fortunate will likely end the year in the red.
But looking ahead, we remain very concerned that if left unchecked, the meteoric rise in the greenback poses the single biggest risk to global markets due to its influence on commodities prices and debt servicing.
Most commodities are denominated in U.S. dollars, meaning they inherently have an inverse relationship: when the value of the dollar rises, it takes less dollars to buy commodities, and vice versa. Consequently, commodities prices have fallen to decade lows this year while the dollar has rocketed to decade highs.
Most worrisome are oil prices, which have recently fallen below $40 US per barrel and are now destabilizing the Middle East and other large oil-producing regions such as Venezuela and Brazil.
In the Middle East, the countries of the Gulf Cooperation Council are running large deficits estimated at $125 billion US in 2015 and expected to total over half-a-trillion dollars over the next four years, according to the International Monetary Fund. The current CDS market, as cited by Reuters, now puts the risk of a sovereign debt default by Saudi Arabia higher than the Philippines.
The real pain is being felt by countries such as Brazil, which is facing its deepest recession since 1990 and has been unsuccessful in attempts to stop its currency from collapsing, resulting in a 10 per cent inflation rate. As a result, Brazil and countries that have similar issues have been borrowing heavily to fund their large trade gaps.
In the past five years, emerging countries have seen their dollardenominated debt levels explode, more than doubling from $2 trillion to $4.5 trillion US, according to the Bank for International Settlements and cited in the Economist. Their debt payments, meanwhile, have increased by 20 to 50 per cent in the past year alone thanks to the rise in the dollar against their local currency.
What will happen as their revenue streams fall even further because of sub-$40 US per barrel oil prices while global high-yield debt markets dry up? They certainly are not going to be able to put more capital in the ground to replace their depleting oil reserves.
Conditions aren’t much better in North America.
Ultralow interest rates have resulted in a lot of demand for highyield bonds, which now represent approximately 15 per cent of the $7.8-trillion US corporate bond market in the U.S. Approximately $200 billion US, or 17 per cent, of the junk bond market is now in the U.S. energy sector, which began borrowing heavily in 2014 and are now just starting to get into serious trouble.
According to Fitch, the 12-month trailing default rate in energy was 5.3 per cent at the end of October, the highest level since 1999. There have also been 19 defaults to date in 2015, and another 15 companies recently filed for bankruptcy, according to Standard and Poors and cited by Energy Intelligence.
This trend is expected to accelerate. Some estimate that those energy companies with high-yield bond issues will have $10 billion US of negative free cash flow next year thanks to falling oil and natural gas prices and interest servicing costs amounting to more than 80 per cent of operating cash flow.
There are also clues in what lies ahead with $70 billion US of asset writedowns this year, which is more than the entire past decade combined.
Even worse, these companies will no longer be able to capitalize their depleting production levels, despite improved cost efficiencies.
And all the while the dollar keeps surging higher and oil prices lower.