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Currencies: Where to hide?
New York: November 12, 2003
By John R. Stephenson

The data out of the U.S. has been encouraging lately with strong economic growth recorded for the third quarter of this year (7.2% GDP growth) and with U.S. production data, purchasing manager data and consumer confidence data improving in recent weeks. In fact, economic data for the G-7 (seven largest economies in the world) has also seemed to be trending upwards (see figure 1). Yet the mood on the street is decidedly somber with the broad indices trading down for the past three sessions and with CNN’s Lou Dobbs talking about the “exporting of America”. Last week Alan Greenspan (chairman of the Fed) mentioned that the Fed was in no hurry to raise interest rates because “the probability, though minor, of an unwelcome fall in inflation exceeds that of a rise in inflation” - a sign that the Fed is concerned that the U.S. economy may not yet have turned the corner.

Figure 1: G-7 Indicators

The Fed has some good reasons to be concerned about the state of the U.S. economy. Last month, we saw a rise in consumer credit (household debt) and the national savings rate for October dipped below 3% of disposable income. As well, capacity utilization for industry is running below 75%, which negates the possibility of increased investment in domestic capacity anytime soon. Certainly one consequence of an increasingly global world is that a greater percentage of the manufacturing is, in fact, being exported abroad.

In order to fund domestic growth over the last few quarters, the U.S. has continued to borrow money. How much money? So far, the total tab of all U.S. government borrowing stands at $3.8 trillion (total U.S. debt outstanding including corporate bonds is $21 trillion - about twice the GDP). Of that amount, foreigners hold about 26% of the total including 36% of the total in U.S. treasuries and 13% of the U.S. agency debt. This, of course, makes the U.S. vulnerable to economic conditions and sentiments abroad. How long can the borrowing continue? It depends, in large part, on the assumed growth rates in the U.S. and the expected yields from U.S. government paper. With the U.S. dollar down some 7% on a trade-weighted basis since the beginning of the year, one wonders if foreigners (mainly Asian governments) can and will continue to fund the U.S. economic engine and indeed as a consequence, lend support to the dollar.

So where should you put your money given our view that economic growth will slow in the U.S. over the coming quarter and that the U.S. dollar will continue to slide against other major currencies? Our analysis leads us to the following conclusions: investors are best advised over the next three months to underweight the U.S. dollar and overweight the U.K. pound and Japanese Yen. Other currencies that investors might want to overweight in declining order are the Australian dollar, Swiss Franc and Canadian dollar. All of these currencies promise greater upside and less downside risk than holding U.S. dollar denominated assets.

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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