How to Profit From the Shrinking Dollar
Treasury Secretary Timothy Geithner on Tuesday said the U.S. would never intentionally weaken the dollar. But that doesn't mean the struggling currency, mired at a three-year low, is poised for a big rally soon.
The dollar's slide doesn't have to be bad news for investors, however. If you live in the U.S. and expect to spend your savings here in the States, a declining dollar doesn't matter so much. There are even ways to benefit from it: While a violent plunge would likely send stock and bond markets reeling, an orderly selloff could be a boon for certain riskier assets.
At the same time, you should be on guard, because some of the same forces that are driving the dollar's slide also could lead to inflation down the road-which would erode your purchasing power.
The dollar has dropped 5.8% against the world's major currencies in 2011, according to the Federal Reserve's trade-weighted index, its worst start to a year since 1995. It is trading at a 29-year low against Australia's dollar, and only recently bounced off a record low against the yen. Even the euro, which is still wrestling with the possible default of Greece and Ireland, has gained 10% against the dollar this year.
The main drivers of the dollar's weakness, say economists, are the twin pillars of economic intervention: monetary and fiscal policy. 'The market is concerned about the deficit and the Fed,' says Jessica Hoversen, fixed-income and foreign-exchange analyst for MF Global Holdings Ltd.
Most worrisome in the short term: monetary policy. While the Federal Reserve in June will end its program of buying bonds to boost the economy, Chairman Ben Bernanke said Wednesday that the Fed will keep interest rates low for an 'extended period'-even as central banks around the globe raise rates to head off budding inflation.
Already, investors have been buying fewer low-yielding dollars, and favoring the currencies of emerging markets and smaller developed markets. The Canadian dollar, for example, has jumped 4.6% against the dollar this year.
'The outlook for monetary policy has not turned around,' says Jens Nordvig, head of G-10 foreign-exchange strategy at Nomura Holdings Inc. in New York. 'It's a little early to bet on the dollar.'
Longer term, investors are concerned about fiscal policy. The budget outlook is so poor that Standard & Poor's on April 18 said the U.S. could lose its vaunted triple-A credit rating. The deficit is expected to hit 10.4% of gross domestic product in 2011, according to the International Monetary Fund, making the U.S. the only developed nation whose shortfall is projected to grow.
Of course, the dollar's recent slide could reverse itself quickly. If investors suddenly were to sour on riskier assets, they could well seek a safe haven in the dollar. That has happened many times over the years, most recently during the financial crisis in 2008 and Europe's debt crisis last year.
Yet most analysts expect the dollar's weakness to continue. 'I can't imagine a scenario where all the players in Washington actually do the hard thing and arrest the decline of the dollar,' says J. Michael Martin, chief investment officer of Financial Advantage Inc., an investment advisory in Columbia, Md. 'Our working assumption is that the dollar will continue to be debased.'
Here's how to play the weak dollar wisely.
Stocks
A slumping dollar historically has been good for stocks. The classic stock play during periods of dollar weakness is large-cap companies that export heavily: Companies in the S&P 500 index derive nearly half of their revenues from abroad, notes Howard Silverblatt, senior index analyst at Standard & Poor's.
Such companies benefit from a weaker dollar in two ways. In the shorter term, profits rise as companies convert their foreign sales into dollars. In the longer term, their products become more competitive in overseas markets, boosting revenue as well.
Barry Knapp, U.S. equity portfolio strategist at Barclays Capital, says big stocks are poised to outperform. He points to the fourth quarter of 2003, when the Federal funds rate hovered at 1%, triggering inflation fears that sent the dollar down 5.8%. The large-cap S&P 500-stock index surged 11.6%.
Large-cap technology companies usually see an uptick in their stock price when the dollar flails, says Emily Sanders, chief investment officer at Norcross, Ga.-based Sanders Financial Management Inc. Of the 10 sectors in the S&P 500, information technology generates the highest proportion of revenues outside the U.S.-an average of 57%, notes Ms. Sanders.
She says she especially likes International Business Machines Corp., whose sales increased 8% during the first quarter, with more than one-third of the gain coming from a weakening dollar. Most of her clients own the company in their portfolios.
The surprise lately has been the performance of small and midcap companies-those with market valuations of less than $5 billion. During the past 120 days, midcaps have seen their 'correlation' with the ICE US Dollar Index-the degree to which the two trade together-fall to minus-0.76 from minus-0.55. (A correlation of 1.0 means two assets trade in perfect lockstep; a correlation of minus-1.0 means they trade in perfect opposition.)
Small caps-companies with an average market value of less than $1 billion or so-have seen their dollar correlations fall to minus-0.68 from minus-0.53. Large caps' correlation fell only slightly to minus-0.69 from minus-0.64.
In other words, as the dollar has weakened, midcaps have risen the most: The S&P Midcap 400 index has jumped 12% during the period, while the S&P Small Cap 600 has gained 10% and the S&P 500 is up 8.2%.
Why have smaller stocks rallied more? Strategists note that investors aren't yet viewing the dollar's fall as a crisis, and therefore are more eager to take risk during a period of easy monetary policy. For instance, Gregory Peterson, director of investment research at wealth manager Ballentine Partners LLC, says he has advised clients to increase their exposure to small-cap manufacturing companies this year.
But if investors start paying more attention to fundamentals, then it may be large-caps' turn to shine, since they tend to be more exposed to foreign markets, says Vadim Zlotnikov, chief market strategist at AllianceBernstein. 'To the extent that the fall in the dollar becomes viewed in the context of superior international earnings, it should benefit large-cap stocks,' Mr. Zlotnikov says.
Bonds
Right now, the falling dollar is having little impact on Treasurys. The yield on the 10-year note is currently 3.31%, barely budging from the 3.37% it registered on Dec. 31.
That state of affairs is unlikely to continue, says Aneta Markowska, a senior U.S. economist at Société Générale in New York. She looks to history as a guide. During the 12 months beginning in April 1986, the dollar fell 15%, while yields on the 10-year Treasury rose only from 7.4% to 7.5%. By the end of the year, she notes, yields had spiked to 8.9%, as the dollar plummeted an additional 11%.
'Dollar weakness didn't matter, until it did,' Ms. Markowska says. 'I think that's a risk facing us again.'
For the time being, the weak dollar may benefit corporate bonds-especially those with foreign revenue streams. As profits rise, those bonds look safer, notes Matt Toms, head of U.S. public fixed income at ING Investment Management.
If the dollar's drop turns into a panic, bond investors would be wise to avoid U.S. Treasurys altogether and focus on well-diversified international bond funds, says Rob Williams, director of income planning for Charles Schwab Corp.'s Center for Financial Research.
Ms. Sanders says she likes the Templeton International Bond Fund, which holds Australian, Polish and Korean bonds, among others. Over the past 12 months, the fund has returned 4%. It carries a top five-star rating by investment researcher Morningstar Inc.
Commodities
Commodities can serve as a hedge against the falling dollar because they are priced in the U.S. currency-so as the dollar weakens the price of the commodity rises. That's one reason why the S&P GSCI Commodity Index, a basket of energy, metal and agricultural commodities, has gained 19% this year.
'The dollar will remain weak as long as the Fed keeps rates low,' says Ballentine Partners' Mr. Peterson. 'As long as that goes on, commodity exposure will be a good thing to have.'
But if the dollar were to free-fall, gold would likely be the biggest beneficiary, say advisers and strategists. That is because gold, more than any other commodity, is viewed as a safe haven investment in global markets. In a weak-dollar world, 'You want to invest in assets like gold,' says Dawn Bennett, chief executive of Washington-based financial-advisory firm Bennett Group Financial Services, who has her clients in the soft metal.
Louis P. Stanasolovich, chief executive of Pittsburgh-based Legend Financial Advisors Inc., expects the dollar to fall by at least 5% annually over the next four years. He says he is putting his clients into exchange-traded funds, such as SPDR Gold Trust, which is up 31% over the last 12 months. In all, he plans to keep his overall gold holdings at about 15%, significantly higher than the 5% or so that most advisers recommend investors allocate to commodities.
Another way to invest in gold is through mutual funds like First Eagle Gold, which holds a combination of bullion and some of the largest mining companies. The fund is up 24% over the past 12 months. Its mixture of equities and commodities provides a hedge against large market swings, says Mr. Stanasolovich, who has bought shares.
Be warned: most commodities have rallied during the past 12 months. Gold is up 31%, while silver is up 171% and copper has gained 26%. Any reversals in the weak-dollar trend could hit these assets hard.
Currencies
Just because the dollar is falling doesn't mean investors should flock to any old currency for protection. Two factors are particularly crucial in foreshadowing whether a currency will appreciate in the long-term: a nation's interest rates and its current-account balance, or the amount of money owed to it by other nations (or the amount it owes others). When interest rates rise, like in Brazil and Australia, investments denominated in those currencies become more attractive to investors seeking yield.
Yet even currencies that meet both of these criteria aren't necessarily worth buying. For instance, while Europe's central bank is raising interest rates and its current account is balanced, the deteriorating situation in Portugal, Ireland and Greece casts a shadow over the euro. After rallying 9% this year, the euro probably isn't a good buy now, says Rebecca Patterson, chief global market strategist at J.P. Morgan Asset Management.
'I wouldn't be putting on a position at these levels,' Ms. Patterson says. 'I would rather own Australia, Canada or any of the emerging Asia currencies.'
Her favorite is China's yuan. China's current account balance is expected to total 3.6% of gross domestic product in 2011, according to the Word Bank. Its leaders have also made clear that they want to rebalance their economy away from exports and toward domestic demand, which will require a stronger currency. A stronger currency would also help China tame inflation, which rose 5.2% in March, because the currency will retain more of its purchasing power.
Although China pegs its currency to the dollar, it has let the dollar slide 4.4% against the yuan during the past 12 months. And if the world slips back into crisis, China is unlikely to devalue its currency-it was the only Asian nation that didn't do so in 2008.
'For now, it's a one-way bet,' Ms. Patterson says.
The dollar's slide doesn't have to be bad news for investors, however. If you live in the U.S. and expect to spend your savings here in the States, a declining dollar doesn't matter so much. There are even ways to benefit from it: While a violent plunge would likely send stock and bond markets reeling, an orderly selloff could be a boon for certain riskier assets.
At the same time, you should be on guard, because some of the same forces that are driving the dollar's slide also could lead to inflation down the road-which would erode your purchasing power.
The dollar has dropped 5.8% against the world's major currencies in 2011, according to the Federal Reserve's trade-weighted index, its worst start to a year since 1995. It is trading at a 29-year low against Australia's dollar, and only recently bounced off a record low against the yen. Even the euro, which is still wrestling with the possible default of Greece and Ireland, has gained 10% against the dollar this year.
The main drivers of the dollar's weakness, say economists, are the twin pillars of economic intervention: monetary and fiscal policy. 'The market is concerned about the deficit and the Fed,' says Jessica Hoversen, fixed-income and foreign-exchange analyst for MF Global Holdings Ltd.
Most worrisome in the short term: monetary policy. While the Federal Reserve in June will end its program of buying bonds to boost the economy, Chairman Ben Bernanke said Wednesday that the Fed will keep interest rates low for an 'extended period'-even as central banks around the globe raise rates to head off budding inflation.
Already, investors have been buying fewer low-yielding dollars, and favoring the currencies of emerging markets and smaller developed markets. The Canadian dollar, for example, has jumped 4.6% against the dollar this year.
'The outlook for monetary policy has not turned around,' says Jens Nordvig, head of G-10 foreign-exchange strategy at Nomura Holdings Inc. in New York. 'It's a little early to bet on the dollar.'
Longer term, investors are concerned about fiscal policy. The budget outlook is so poor that Standard & Poor's on April 18 said the U.S. could lose its vaunted triple-A credit rating. The deficit is expected to hit 10.4% of gross domestic product in 2011, according to the International Monetary Fund, making the U.S. the only developed nation whose shortfall is projected to grow.
Of course, the dollar's recent slide could reverse itself quickly. If investors suddenly were to sour on riskier assets, they could well seek a safe haven in the dollar. That has happened many times over the years, most recently during the financial crisis in 2008 and Europe's debt crisis last year.
Yet most analysts expect the dollar's weakness to continue. 'I can't imagine a scenario where all the players in Washington actually do the hard thing and arrest the decline of the dollar,' says J. Michael Martin, chief investment officer of Financial Advantage Inc., an investment advisory in Columbia, Md. 'Our working assumption is that the dollar will continue to be debased.'
Here's how to play the weak dollar wisely.
Stocks
A slumping dollar historically has been good for stocks. The classic stock play during periods of dollar weakness is large-cap companies that export heavily: Companies in the S&P 500 index derive nearly half of their revenues from abroad, notes Howard Silverblatt, senior index analyst at Standard & Poor's.
Such companies benefit from a weaker dollar in two ways. In the shorter term, profits rise as companies convert their foreign sales into dollars. In the longer term, their products become more competitive in overseas markets, boosting revenue as well.
Barry Knapp, U.S. equity portfolio strategist at Barclays Capital, says big stocks are poised to outperform. He points to the fourth quarter of 2003, when the Federal funds rate hovered at 1%, triggering inflation fears that sent the dollar down 5.8%. The large-cap S&P 500-stock index surged 11.6%.
Large-cap technology companies usually see an uptick in their stock price when the dollar flails, says Emily Sanders, chief investment officer at Norcross, Ga.-based Sanders Financial Management Inc. Of the 10 sectors in the S&P 500, information technology generates the highest proportion of revenues outside the U.S.-an average of 57%, notes Ms. Sanders.
She says she especially likes International Business Machines Corp., whose sales increased 8% during the first quarter, with more than one-third of the gain coming from a weakening dollar. Most of her clients own the company in their portfolios.
The surprise lately has been the performance of small and midcap companies-those with market valuations of less than $5 billion. During the past 120 days, midcaps have seen their 'correlation' with the ICE US Dollar Index-the degree to which the two trade together-fall to minus-0.76 from minus-0.55. (A correlation of 1.0 means two assets trade in perfect lockstep; a correlation of minus-1.0 means they trade in perfect opposition.)
Small caps-companies with an average market value of less than $1 billion or so-have seen their dollar correlations fall to minus-0.68 from minus-0.53. Large caps' correlation fell only slightly to minus-0.69 from minus-0.64.
In other words, as the dollar has weakened, midcaps have risen the most: The S&P Midcap 400 index has jumped 12% during the period, while the S&P Small Cap 600 has gained 10% and the S&P 500 is up 8.2%.
Why have smaller stocks rallied more? Strategists note that investors aren't yet viewing the dollar's fall as a crisis, and therefore are more eager to take risk during a period of easy monetary policy. For instance, Gregory Peterson, director of investment research at wealth manager Ballentine Partners LLC, says he has advised clients to increase their exposure to small-cap manufacturing companies this year.
But if investors start paying more attention to fundamentals, then it may be large-caps' turn to shine, since they tend to be more exposed to foreign markets, says Vadim Zlotnikov, chief market strategist at AllianceBernstein. 'To the extent that the fall in the dollar becomes viewed in the context of superior international earnings, it should benefit large-cap stocks,' Mr. Zlotnikov says.
Bonds
Right now, the falling dollar is having little impact on Treasurys. The yield on the 10-year note is currently 3.31%, barely budging from the 3.37% it registered on Dec. 31.
That state of affairs is unlikely to continue, says Aneta Markowska, a senior U.S. economist at Société Générale in New York. She looks to history as a guide. During the 12 months beginning in April 1986, the dollar fell 15%, while yields on the 10-year Treasury rose only from 7.4% to 7.5%. By the end of the year, she notes, yields had spiked to 8.9%, as the dollar plummeted an additional 11%.
'Dollar weakness didn't matter, until it did,' Ms. Markowska says. 'I think that's a risk facing us again.'
For the time being, the weak dollar may benefit corporate bonds-especially those with foreign revenue streams. As profits rise, those bonds look safer, notes Matt Toms, head of U.S. public fixed income at ING Investment Management.
If the dollar's drop turns into a panic, bond investors would be wise to avoid U.S. Treasurys altogether and focus on well-diversified international bond funds, says Rob Williams, director of income planning for Charles Schwab Corp.'s Center for Financial Research.
Ms. Sanders says she likes the Templeton International Bond Fund, which holds Australian, Polish and Korean bonds, among others. Over the past 12 months, the fund has returned 4%. It carries a top five-star rating by investment researcher Morningstar Inc.
Commodities
Commodities can serve as a hedge against the falling dollar because they are priced in the U.S. currency-so as the dollar weakens the price of the commodity rises. That's one reason why the S&P GSCI Commodity Index, a basket of energy, metal and agricultural commodities, has gained 19% this year.
'The dollar will remain weak as long as the Fed keeps rates low,' says Ballentine Partners' Mr. Peterson. 'As long as that goes on, commodity exposure will be a good thing to have.'
But if the dollar were to free-fall, gold would likely be the biggest beneficiary, say advisers and strategists. That is because gold, more than any other commodity, is viewed as a safe haven investment in global markets. In a weak-dollar world, 'You want to invest in assets like gold,' says Dawn Bennett, chief executive of Washington-based financial-advisory firm Bennett Group Financial Services, who has her clients in the soft metal.
Louis P. Stanasolovich, chief executive of Pittsburgh-based Legend Financial Advisors Inc., expects the dollar to fall by at least 5% annually over the next four years. He says he is putting his clients into exchange-traded funds, such as SPDR Gold Trust, which is up 31% over the last 12 months. In all, he plans to keep his overall gold holdings at about 15%, significantly higher than the 5% or so that most advisers recommend investors allocate to commodities.
Another way to invest in gold is through mutual funds like First Eagle Gold, which holds a combination of bullion and some of the largest mining companies. The fund is up 24% over the past 12 months. Its mixture of equities and commodities provides a hedge against large market swings, says Mr. Stanasolovich, who has bought shares.
Be warned: most commodities have rallied during the past 12 months. Gold is up 31%, while silver is up 171% and copper has gained 26%. Any reversals in the weak-dollar trend could hit these assets hard.
Currencies
Just because the dollar is falling doesn't mean investors should flock to any old currency for protection. Two factors are particularly crucial in foreshadowing whether a currency will appreciate in the long-term: a nation's interest rates and its current-account balance, or the amount of money owed to it by other nations (or the amount it owes others). When interest rates rise, like in Brazil and Australia, investments denominated in those currencies become more attractive to investors seeking yield.
Yet even currencies that meet both of these criteria aren't necessarily worth buying. For instance, while Europe's central bank is raising interest rates and its current account is balanced, the deteriorating situation in Portugal, Ireland and Greece casts a shadow over the euro. After rallying 9% this year, the euro probably isn't a good buy now, says Rebecca Patterson, chief global market strategist at J.P. Morgan Asset Management.
'I wouldn't be putting on a position at these levels,' Ms. Patterson says. 'I would rather own Australia, Canada or any of the emerging Asia currencies.'
Her favorite is China's yuan. China's current account balance is expected to total 3.6% of gross domestic product in 2011, according to the Word Bank. Its leaders have also made clear that they want to rebalance their economy away from exports and toward domestic demand, which will require a stronger currency. A stronger currency would also help China tame inflation, which rose 5.2% in March, because the currency will retain more of its purchasing power.
Although China pegs its currency to the dollar, it has let the dollar slide 4.4% against the yuan during the past 12 months. And if the world slips back into crisis, China is unlikely to devalue its currency-it was the only Asian nation that didn't do so in 2008.
'For now, it's a one-way bet,' Ms. Patterson says.
Comments
Post a Comment