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Markets: The Dollar and Stocks
New York: January 17, 2005
By John R. Stephenson

With the U.S. government working hard to debase the currency and a lower dollar almost a certainty, the one question that remains to be answered is - how to benefit? Although Asian governments (notably China and Japan) have been buying up all the U.S. treasuries they can get their hands on to support the dollar and stimulate this one-way trade (in a massive case of vendor finance), the enormous weight of the American twin deficits (government and current account deficits) may become too much. Already the dollar has fallen substantially against the currencies of its major trading partners and the likelihood is that the U.S. dollar will continue to fall further in 2005.

Currency traders, like investors of all kinds, are looking for a return on their investment. Strong economies have strong currencies and unfortunately, the U.S. is not an overly strong economy - at least not on closer inspection. Americans have been living high off the hog for some time and since we consume more than we produce, we are dependent on the kindness of strangers (mainly Asian central banks) for the lifestyle we enjoy. Currently, we are the world's largest debtor nation and, unfortunately, we are not putting the borrowed money toward anything productive. With a huge current account deficit (exports minus imports), and with enormous government expenditures on health care, unemployment insurance and a war in Iraq with no end in sight, our economic house is not in order. The one bright light has been the willingness of the U.S. consumer to keep on spending, but with wage growth almost stagnant, the U.S. Federal Reserve (U.S. Central Bank) has adopted a policy of providing consumers and businesses with costless short-term financing (through negative real, short-term interest rates). While this policy of zero interest financing has benefited us in the short-run by staving off deflation (falling asset prices), it has only served to perpetuate a bubble in the housing sector and in financial assets that will eventually pop.

Every month, the U.S. government releases massaged numbers professing that U.S. productivity is steadily improving against that of the rest of the world. Yet the currency market knows better - just as money markets throughout history have always ignored the phony proclamations of rulers, so, too, do professional currency traders. Until Americans stop spending and start saving and investing in something productive, the currency will continue to slip against the currencies of more productive nations. Judging by recent comments by Fed Chairman Alan Greenspan and many of his colleagues at the Federal Reserve, it seems as if U.S. policymakers are finally beginning to acknowledge the likelihood of a slide in the U.S. dollar. Financial institutions such as Goldman Sachs are on record as saying that they believe the U.S. dollar will drop a further 15% against other world currencies.

To capitalize on a decline in the U.S. dollar, investors should consider investments in companies (stocks), which could experience earnings growth, and margin benefits from a falling U.S. dollar. Companies that have local (non-U.S.) revenues and U.S. dollar costs could experience improving margins (revenues rise while costs drop) and a possible resultant expansion in their price/earnings multiple. As well, companies that have both their costs and their revenues in a foreign currency should experience a positive lift as these numbers are translated back into U.S. dollars.

Companies in the travel industry are another likely beneficiary of a falling dollar because Americans will be more inclined to travel within the United States. As well, it will be less expensive than it used to be for a foreigner to travel to the United States. These trends should lead to an increased market share for domestic travel companies and to positive earnings revisions which will, in turn, lead to higher stock prices.

Given the magnitude of the problems at home and the lack of appetite for a coordinated global effort to stem the U.S. dollar decline, there is a risk that U.S. dollar weakness could accelerate and become disorderly. If that were to be the case, investors should look to the safe haven currencies such as the Swiss franc (CHF) or the euro (EUR) as alternatives to their holdings in U.S. dollar investments. Although buying shares in U.S. companies with extensive overseas operations is one way to hedge against a likely decline in the U.S. dollar, the best way to insulate yourself as an investor is by holding positions directly in the currencies of countries (such as Switzerland, Euroland and Japan) who are the likely beneficiaries of a drop in the dollar.

Figure 1: Stocks that Should Benefit from a declining U.S. Dollar

Source: Compustat, company filings, Goldman Sachs Research

 

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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