Investments For A Weak Dollar World

By Martin Hutchinson
Director of Global Investing Research

The European euro hit a record value of $1.39 this past week, and the Japanese yen strengthened again to 114 to the dollar, well above the 120 it’s traded at most of the year. The British pound Sterling is at $2.03, back to levels it hadn’t seen since 1980 or so.

For U.S. investors who are not planning a winter vacation in ever-more-expensive Europe, this may not appear to matter much.

However, it’s a trend that’s likely to continue, and it’s worth adjusting your portfolio to take advantage of it.

The Doleful Dollar

The dollar is likely to remain relatively weak for two reasons:

  • First, the United States is still running a $700 billion balance-of-payments deficit with the rest of the world. Asian central banks have been financing this by purchasing Treasury bonds. Indeed, U.S debt comprises a nice chunk of China’s $1.33 trillion in foreign reserves. As we now know German regional banks have also been financing the shortfall by purchasing subprime mortgage debt. (It’s particularly good for the balance of payments when foreigners buy subprime mortgage debt, air-filled dot-coms, or the Brooklyn Bridge because the profit that domestic shysters make from selling worthless assets to foreigners counts as income). Nevertheless, both these trends are showing signs of ending. This means the United States has to export more, which means that the dollar has to drop against the euro, sterling, yen, renminbi and currency of anyone else who might be persuaded to buy U.S. products if they’re cheap enough.
  • And, second, it looks like U.S. Federal Reserve Chairman Ben S. Bernanke will be cutting interest rates. Since the Bank of England, the European Central Bank (ECB), and the Bank of Japan (BOJ) all are closer to raising interest rates instead of cutting them, a Fed rate cut should make the dollar weak. That short-term factor explains the dollar’s current weakness; if Bernanke doesn’t cut rates next Tuesday, it may bounce back. (Unfortunately, if Fed policymakers opt to not cut interest rates, the U.S. stock market will probably fall out of bed).

Assuming you think this trend will continue, what should you be buying?

Currency and Fixed-Income Plays

One possibility is foreign currency itself, preferably in the form of deposits or short-term assets denominated in foreign currencies. However, remember that interest rates seem to be going up, so bonds should be approached with caution (when interest rates increase, those bonds that you bought will drop in market value from what you paid for them).

If your bank will allow you to make foreign currency deposits, that may be the simplest solution. You should avoid sterling, as Britain has many of the same problems (over-bubbly real estate market, too much financial services), though their problems haven’t advanced as far as our have – yet.

In terms of individual currencies, the euro and yen are probably the two best bets.

If you want to buy foreign currency bonds, you might consider a foreign currency bond fund (of which there aren’t very many available in the United States), such as the no-load T. Rowe Price International Bond Fund (RPIBX), which invests in high quality non-dollar-denominated bonds.

Two warnings:

  • First, don’t buy bond funds investing in foreign junk bonds (because then you become like the sleepy and less-than-sharp German banks that invested in subprime mortgages – you don’t know what you’re getting).
  • Second, don’t buy an emerging-markets bond fund, because emerging-markets bond portfolios, unlike stock portfolios, tend to be dominated by the countries with the most debt, which are consequently in most danger of defaulting.

There’s a second possibility. Don’t buy bonds. Buy stocks.

Buy a Stake in the Leaders

The second possibility is to buy shares of U.S. companies with a lot of foreign business. These will benefit from a weak dollar in two ways:

  • First, if they do business as local companies overseas, their assets and income in foreign countries will be worth more when translated back into dollars so that the company can consolidate its financial statements and report its performance to its U.S. shareholders.
  • Second, if they export from the United States, their income will go up relative to their costs – a wonderful position to be in. There are lots of these companies. But the two of the best examples would be Coca Cola Co. (KO), which does business all over the world, and Boeing (BA), which is the United States’ largest exporter. Both stocks are currently trading at price-earnings ratios of over 20 – placing them on the pricey side – but the earnings going forward should be strong.
  • Third, you can buy foreign company shares (avoiding companies exporting heavily to the United States, who suffer from a weak dollar just as Boeing benefits from it). Here you might as well benefit from rapid Asian growth. One possibility would be the streetTracks SmallCap Japan ETF (JSC) which invests in Japanese smaller (and, therefore, mostly domestic) companies. Another is SK Telecom (SKM), Korea’s largest cell-phone company, which has international operations in China, Vietnam and the United States, although the U.S. market is only a small part of its operations.

Probably a mix of strategies would work best. You shouldn’t turn your portfolio upside down to bet on a weak dollar, but you might as well make sure that some of your money is invested to benefit from it.

Related News and Story Links: