Contrary to popular belief, equity markets in countries experiencing currency weakness are more likely to outperform than those in strong currency environments.
These surprising conclusions are the result of a joint study conducted by ABN Amro and the London Business School. The study looked at data from 53 countries going back to 1900.
The exchange rate has two countervailing effects on equity markets. On the one hand a weak domestic currency is generally assumed to increase corporate earnings because it boosts export competitiveness. When the UK was ejected from the European exchange rate mechanism in 1992, for example, UK exporters under pressure from the high exchange rate received an instant boost.
On the other hand, a depreciating currency tends to increase inflation and inflation expectations, which can have a negative effect on a company’s stock market rating, lowering PE ratios.
| All power to the weakest Performance of equity markets ranked by prior change in the exchange rate, 1900-2005 |
| Source: ABN Amro |
"The argument has tended to be that weak currencies go hand in hand with poor performance,” says Paul Marsh, a professor at London Business School.