The Dow and the dollar -- the two go hand-in-hand
10:08 a.m. Sep 18, 1998 Eastern
By Henry Engler
LONDON, Sept 18 (Reuters) - The spectacular rise in U.S. stock prices over the past three years, fuelled by a growing share of foreign money, means the dollar stands to suffer more than during past market downturns, say analysts.
''The long-term links have gotten stronger,'' said James McCormick, an analyst at J.P. Morgan. ''More foreigners are in the U.S. stock market, so when the market performs poorly it hits the dollar more directly than it has in the past.''
As an example, since August 17, when Russia devalued the rouble, the S&P 500 has slid by four percent while the dollar has fallen by 6.6 percent against the German mark.
The correlation, say analysts, reflects the increased globalisation of capital markets which have enticed foreign investors to put a rising share of funds into the U.S. market.
Looking at the data, corporate equities as a percentage of foreign net purchases of U.S. assets have grown considerably, climbing to 8.7 percent over the past three years after a rise of only 3.2 percent between 1980 and 1995.
U.S. credit market instruments, particularly Treasuries, still remain the dominant U.S. financial asset in foreign portfolios, making up almost 65 percent of the total.
Another factor which has accelerated the recent trend is the turmoil in Latin America, a part of the globe that has much closer trade and investment links with the United States.
Analysts note that during much of Asia's crisis the dollar remained relatively strong, helped in part by its perceived safe-haven status. But now, as the global economic downturn has widened, the U.S. economy is no longer seen as immune.
''I think what you're seeing now is with Latin America under pressure you can no longer see the U.S. as a safe haven,'' added McCormick.
Others point to the fact that the U.S. and other economies with large current account deficits have seen their currencies suffer more because of the desire of investors to repatriate funds in times of increased risk.
For example, despite all the economic and banking problems currently afflicting Japan, the yen has risen sharply against the dollar along with currencies such as the Swiss franc.
Japan's status as the world's biggest creditor is playing a role in the yen's strength, says Paul Meggyesi, senior currency economist at Deutsche Bank, a factor which can be seen working in other currencies as well.
''The simple reason the yen has been so strong is that Japanese investors own the world -- the world doesn't own Japan,'' he said.
Goldman Sachs estimates that America's current account deficit was 2.1 percent of GDP in 1997, compared with surpluses of 2.3 percent in Japan and an astonishing 7.9 percent in Switzerland.
Over the past month, the two best performing currencies against the dollar have been the yen, which is up 9.6 percent, and the Swiss franc, up 8.4 percent.
Apart from the U.S. dollar, only the Canadian and Australian dollar have suffered more during the same period, two countries with current account deficits similar to or larger than that of the United States, says Meggyesi.
Regarding the yen, McCormick of J.P. Morgan believes there is more at work than just Japan's status as global creditor. During times of financial stress numerous trading positions are automatically unwound which tends to push the yen higher.
He agrees that Japan's huge investments abroad are being brought home, another plus for the yen, but once the heightened sense of risk aversion subsides among international investors, many will once again focus on economic fundamentals.
When that happens, the yen will likely suffer, he said.
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