The dollar may have plunged to a record low against the euro, but the weakness may present good possibilities for U.S. investors
The weak U.S. dollar just got weaker, hitting its lowest level ever against the euro on Sept. 12. The hit to Americans' buying power abroad is substantial, as any tourist back from a summer vacation in Europe can tell you. But, so far, policymakers and market experts seem unruffled.
Rather than something to worry about, the dollar's decline is "something to cheer about," says Avery Shenfeld, senior economist at CIBC World Markets (CM).
The trigger for the latest round of dollar declines, experts say, is the growing certainty that the Federal Reserve is poised to cut U.S. interest rates at its Sept. 18 meeting. It's Econ 101: When interest rates fall, investors holding U.S. currency will see lower returns. So, they move their money elsewhere at a time when central banks in Europe and elsewhere are holding rates steady.
Weak Dollar: Who Benefits
So far, the dollar's "decline has been orderly and fundamentally understandable," says Marc Chandler, global head of currency strategy at Brown Brothers Harriman Brown Brothers Harriman.
There's an irony in the dollar's recent hard times. In times of global financial panic, the U.S. is often seen as a safe haven, a place to flee from risk. Thus, "traditionally this would be a period that benefited the dollar," Martin Jansen, senior portfolio manager at ING Investment Management (ING) says, referring to the recent credit crunch. However, the credit crisis, beginning with defaults on subprime mortgages, is largely an American creation, and it appears U.S. growth may slow as a result. Investors are finding other places to protect their money.
A weak dollar may hurt U.S. prestige, but it actually helps key parts of stock market. Many stocks, especially those of large-cap, international companies, get much of their profits from abroad. Paul Larson, equities strategist at Morningstar (MORN), points to companies like Colgate-Palmolive (CL) or Coca-Cola (KO) that, though headquartered in the U.S., rely heavily on foreign consumers.
Foreign Investors Could Flee
Those companies, already benefiting from global growth that's much faster than U.S. growth, will get an added boost as overseas earnings are translated into dollars. The extra earnings should show up in corporate earnings reports and analysts' estimates, helping price-to-earnings ratios on U.S. exchanges.
However, "there's a two-edged sword here," Jansen says. There's some debate about what impact a weaker dollar has on smaller companies, which often aren't diversified overseas and must rely on the slow-growing U.S. economy.
Small companies may be hurt by their domestic focus, and there's also the danger that foreign investors will lose enthusiasm for U.S. stocks as the dollar falls. Measured in U.S. dollars, indexes such as the broad Standard & Poor's 500 have provided great returns. But, measured in foreign currency, the index's returns look only lackluster in recent years.
Crude Oil Prices on the Rise
Benefiting from the dollar's decline may be "hard resource companies" like oil and metals companies, Larson says. That's because the U.S. price of commodities rises along with the dollar. But the fact that dollars can buy fewer commodities also puts pressure on American consumers and other firms. It's no coincidence that the U.S. dollar is hitting new lows just as oil prices hit new highs. At one point on Sept. 12, the price of crude oil futures in New York topped $80 before pulling back.
The euro is now worth about $1.39, but earlier this decade the European common currency roughly matched the value of the U.S. dollar. Thus, in the past five years, the price of oil is up about 160% in the U.S., but up only 90% in euros.
Despite these pressures, other benefits may result from a weak dollar. Larson suggests that the outsourcing and offshoring of American jobs, a longstanding trend, may slow. CIBC's Shenfeld says many American companies, even smaller domestic outfits, will benefit because the dollar's decline raises the costs for its foreign competitors. Chandler counters that European and Asian firms focused on the long term will be more concerned about maintaining market share than profits.
How Investors Can Play It
In any case, the biggest benefit of big moves in the U.S. dollar may be to U.S. investors who already are heavily invested in overseas stocks. Financial planners advise Americans to put at least a portion of their portfolio in foreign stocks, to benefit from faster growth overseas.
No one knows if the dollar will continue to slide. There are at least three possible scenarios, experts say. The first: The dollar continues its slow, steady decline. Growth slows in the U.S., pressuring the Fed to cut interest rates further, but growth overseas stays strong, forcing other banks to keep rates high.
The second is that, eventually, a U.S. growth slowdown spreads overseas. "I still think we live in a world where when the U.S. sneezes, the rest of the world gets pneumonia," Chandler says. In this scenario, the Europeans eventually start cutting interest rates, perhaps next year just as the U.S. economy recovers and the Federal Reserve starts raising rates again. That pushes the dollar higher.
Memories of 1995
The third, which many fear but believe is unlikely, is that the drop in the dollar accelerates. "What one worries about is a steady depreciation turns into a rout," Jansen says. "You don't want the pace of the decline to become so brisk that foreigners dump assets," Shenfeld notes.
It's important to remember, however, that the dollar's slide is not unprecedented. The euro may have hit a record high of $1.39 on Sept. 12, but the currency is only about five years old. The now-defunct German mark hit a record high in 1995 that would be the equivalent of a euro level of $1.4575, Chandler says.
If the euro reaches that lofty level, it might be psychologically significant for traders looking for further gains in the currency (though a euro that strong may also hurt European exports). However, Chandler expects the dollar to eventually bounce back like a rubber band. "The dollar's decline seems largely cyclical, not structural," he says.