Investing in currencies offers some of the best opportunities over the next 12 months. For a long only investor, we believe fixed income markets offer limited upside opportunity while equity valuations are no longer as attractive as they used to be.
We remain optimistic about the Norwegian krone's outlook. It has depreciated in recent weeks as a result of falling oil prices, but we expect a reversal. In the meantime we have taken advantage of the current weakness to increase our position. The Mexican peso has weakened against the dollar, but we have structured our investments to take advantage of the relative strength of the Mexican peso against other currencies. We will continue betting on the Mexican peso in the coming months. However, we are currently cautious on the pound, euro, Canadian dollar, Korean won and Polish zloty.
However, one of the major bets this year, which has also been one of the most profitable for us, is the US dollar. We believe that on a 12-18 month time horizon, the dollar will continue to strengthen, especially against the euro. That said, there are concerns that many investors are placing themselves on the same bet. We would not be surprised if the dollar weakens marginally in the near term. As a result, we have reduced our exposure to the US dollar as we would like to increase it after the weakness.
Taking a long-term view, the US dollar has only recently begun to approach its fair value and therefore still has plenty of room for growth. To support the concept expressed above, we can consider the performance of the trade-weighted US dollar index which is adjusted for the inflation of the countries with which the United States trades. On the basis of this index, the recent strengthening of the dollar should be considered modest overall. Both equity and bond market developments offer reasons for the contention that the dollar may still be in an early stage of growth.
The Dow Jones index has outperformed the EuroStoxx index by around 60% over the past five years. Over the past three years, German government bonds have recorded yields 170 basis points lower than US government bonds. Until 3-4 months ago, the EUR/USD was hovering around its five-year average. We believe that the reasons why the US dollar has been slow to appreciate, also with respect to the performance of equities and bonds, are due to various events: the quantitative easing of the United States, the "whatever it takes" discourse of Mario Draghi (who reduced the risk premium on euro assets), and the political and economic situation that occurred earlier this year in the United States (which led investors to question the US recovery).
Many countries welcome the further strengthening of the US dollar as the US currency appears to contribute to the rebalancing of the global economy. It is worth noting that the governments of New Zealand, Korea, Israel and the Czech Republic all stepped in to depreciate their respective currencies as the dollar weakened.
