Beware the Dropping Dollar
A weak greenback may help exporters--but it could hammer your portfolio
too.
FORTUNE
Monday, June 24, 2002
By David Rynecki
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When something raises the hackles of bond investor Bill Gross, it's usually
worth taking note. And lately what's been nagging at the longtime chief
investment officer of fixed-income behemoth Pimco is the sinking value of the
U.S. dollar. Since January it has slipped 7% against the euro and 6% vs. the
yen. Though the decline represents a fraction of the dollar's advance since the
mid-1990s--a period when the buck rose 50%--economists are predicting an
additional 10% to 15% drop before the end of the year. Says Gross: "The
current and potential continuing dollar weakness is one of the most critical
threats to the U.S. economy."
Why the worry? At first glance, a sinking greenback would seem to be good
news for the economy. Manufacturers and exporters, hamstrung by the
strong currency, have lobbied intensely for a gradual weakening of the dollar
to bolster demand for their goods overseas and increase their ability to raise
prices at home. They're clearly going to benefit from a weaker U.S. currency.
Economist Steven Wieting at Salomon Smith Barney estimates that a 10%
decline in the dollar alone would increase S&P 500 profits by 2%.
But look deeper and the danger becomes clear: Over the next few years a
less-than-robust dollar would deprive investors of some of the benefits they've
come to take as givens.
Start with inflation. The strong dollar is credited with helping keep this
bugaboo at bay. By making it more attractive for Americans to buy imported
items, domestic competitors have found it tough to raise prices. That is all
but certain to change with a weaker dollar. By some estimates, a 10% dollar
pullback equals a 1% uptick in core inflation, which would erode the real
returns of bonds and could ultimately convince the Federal Reserve to raise
interest rates--a negative for stocks. Inflation in and of itself isn't great for
stocks either: While nominal profits would rise, the value of each dollar of
profits would drop, meaning that investors would have to pay higher multiples
for stocks that are already trading at historically high levels.
Then there's the likelihood that the incredible gush of overseas investment will
slow to a trickle as the dollar declines. Many Wall Streeters say that money
from abroad was the unsung hero of the bull market. Foreign investors
pumped some $1.3 trillion into U.S. stocks and bonds between 1999 and the
end of 2001, largely because they believed in the soundness of the dollar and
the superiority of U.S. profit growth. Foreigners now own $8 trillion of U.S.
financial assets, including 13% of all stocks, 24% of corporate bonds, and
40% of Treasury bonds, according to Bridgewater Associates.
But a weaker currency, coupled with fundamentals that are less attractive
than those of key foreign markets, could push inflows substantially lower.
Evidence already suggests foreigners are less bullish on U.S. markets.
Morgan Stanley economist Joseph Quinlan reports that fund flows in the first
two months of the year were off some 75% from the prior period. The upshot,
says Pimco's Gross, is that "foreign stocks and bonds will do better than
U.S.-dollar-denominated securities."
All this doesn't necessarily spell doom for the U.S. markets. Economist
Maury Harris at UBS Warburg points out that the S&P 500 rallied from 1985
to 1987, even as the dollar fell by more than 40%. This time around it may be
tougher: A falling dollar is just one more negative for markets already wracked
with anxiety.
George Cole Comment:
What Wall Street spin doctor Maury Harris conveniently ignores is that stock were MUCH CHEAPER in 1985 and the US was MUCH LESS DEPENDENT on foreign capital. Not to speak of the fact that the secular bull still was very young. |
