Canadian Dollar: Has it Turned?

By Craig Basinger, CFA


“When the facts change, I change my mind. What do you do, sir?” – John Maynard Keynes


Has the Canadian Dollar Turned?

To determine whether the Canadian dollar is now undervalued, we need to start by outlining where we are coming from. We have been U.S. dollar bulls for over five years. This is most evident in our Core Income mandate that is primarily focused on Canadian dividend-paying companies but can hold up to 35% U.S. companies for better diversification, both at the company level and from a currency perspective.

Our view on the USD/CAD can be easily seen in how much U.S. equity the portfolio has held over time. When we launched the initial SMA strategy in April 2011, we had below 6% U.S. exposure. Two-year yields were higher in Canada than the U.S., the Fed was adding more quantitative easing, their credit rating had been downgraded, there were persistent debt ceiling issues and oil was between $80-100/bbl.

However, in March 2012, we increased our U.S. weight in the portfolio from below 10% to 25% and by October of that same year we were pretty much at our maximum 35% U.S. weight. None of the aforementioned factors had changed; the increase in U.S. holdings was driven from a fundamental valuation perspective.


Most Currencies Undervalued vs USD

The top chart on the right shows the Canadian dollar in relation to its maximum and minimum value since a floating exchange rate was adopted. While it is a simplistic approach that ignores factors such as oil prices, yield spread, etc., the chart shows that when close to the maximum (green line), upside has been limited, while when close to the minimum (red line) further downside has been limited.

In 2012, the loonie was close to its record level, implying more upside may prove difficult and there may be greater upside in the undervalued U.S. dollar. Also, based on purchasing power parity, looking at the major country currencies, in 2012 all were overvalued against the U.S. dollar except the Swedish Krona. Today, most are undervalued including the Canadian dollar (bottom chart on the right).

Falling from parity to the mid 70-cent range, having U.S. dollar exposure provided a boost to returns. The problem now is, with the Canadian dollar near the lower end of its historical range and somewhat undervalued vs. the U.S. dollar, should we continue to be bullish on U.S. dollar exposure?


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Learn more about Redwood Tactical Asset Allocation Fund (RTA) and Redwood Core Income Equity Fund (RDE)


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