Intro: Short-term currency fluctuations can be driven by several factors that may or may not correspond to fundamental developments. However, the most important variable, particularly in developed markets, is the trend of real interest rates. The Trend of Real Interest Rates/Bond Yields: Real interest rates and bond yields are the most important drivers of currency…
Intro: Over the long term there are four main factors that determine currency performance; the starting valuation, the rate of inflation, real GDP growth, and real interest rates; with the latter being intimately linked. While inflation is the most important factor driving nominal returns, real GDP growth is the major factor driving total return performance…
Intro: Changes in real interest rates are the key drivers of currency movements. In the short term they impact returns on speculative investment flows, while in the long term they determine total return performance. Real interest rates are at the heart of currency movements in both the short term and the long term. Their importance…
Intro: Fiscal policy is perhaps the single most important driver of currency performance, particularly over the long term, due to its impact on inflation and growth, as well as its impact on monetary policymakers’ ability to maintain positive real interest rates. As mentioned previously real interest rates are the major driver of forex moves over…
Intro: Equity markets are driven by the dividend yield, growth in dividends, and changes in how much investors are willing to pay for future dividends (changes in the dividend yield). Factors such as sentiment and trend following drive changes in dividend yields, while dividend growth is a product of economic and corporate fundamentals. Equity market…
Intro: Equity market moves in the short term tend to reflect changes in economic or corporate fundamentals relative to consensus expectations, causing adjustments in prices to reflect the likelihood of higher or lower earnings and dividends in the future. The longer the time horizon, the more important actual earnings and dividends become. Over the very…
Intro: Valuation measures are only as useful as their ability to predict subsequent market returns. The valuations metrics that smooth out the short-term effects of the business cycle on profit margins tends to have the best track record of predicting future returns. For this reason, cyclically-adjusted measure, as well as the simple price-to-sales ratio, tend…
Intro: There are several misunderstandings with regards to the interaction between wealth and equity markets, so-called cash on the sidelines, and role of buybacks in supporting stocks. It is key to remember that equity market wealth is represented not by current equity prices but the stream of future cash flows that investors can expect their…
Intro: More so than any other financial market asset, long-term government bonds tend to closely track the economic fundamentals of a country and are much less susceptible to wild swings compared to equity markets. Supply and demand determine bond prices and therefore yields, with supply impacting demand via inflation. Unlike stocks and currencies, which can…
Intro: Emerging market and developed market bond yields respond differently to changes in domestic and external real GDP growth expectations. To compare emerging and developed local government bond yields it is useful to adjust emerging market yields for default risk on external debt. The difference between yields on emerging market bonds and developed market bonds…
Intro: Default risk refers to the probability that a government defaults on external debt (typically dollars) due to an inability or unwillingness to pay. Below gives the main factors that determine the risk of government default. Government Dollar Debt Relative to Dollar Assets: In order to determine default risk, the government’s debt load is the…