The anemic dollar won’t strengthen any time soon. But neither will it collapse. That’s the overwhelming consensus of economists, forecasters and analysts. For how long will the dollar drift downward? And what are the most effective ways for an equity investor to play the battered greenback?
The U.S. currency began its steady slide in mid-March 2002. At that time, the dollar bought 1.13 euros; in mid-January it was worth just E0.79 -- a 30 percent decline. “The U.S. dollar became very overvalued during the mid-1990s bull market,” says Tim Steward, chief currency strategist for Morgan Stanley & Co. in New York. “We are now seeing a reversal of that trend.”
Although a few foresee an outright dollar collapse, most observers expect the currency to continue to descend in a controlled fashion. Explains Chris Tracey, a global strategist at J.P. Morgan Fleming Asset Management in London: “The U.S. economy is still growing faster than the economies of Europe and Japan, and the alternatives to U.S. securities markets aren’t particularly attractive. This is a big reason why the dollar’s decline has been gradual, and this will continue.”
Another force mitigating the dollar’s decline has been intervention by the Chinese and Japanese central banks. This “has prevented any dollar decline against the Chinese currency, and it’s muted the dollar’s decline against the Japanese yen,” says Jason Bonanca, currency strategist at Credit Suisse First Boston in New York. “The Chinese government is very determined to maintain an advantageous exchange rate, which it needs to maintain strong economic growth.” GDP growth in China was 9.1 percent in 2003, according to statistics recently released by the Chinese government.
How are stock pickers playing the dollar in the doldrums? In the main, they’re betting on U.S. manufacturers and commodity producers that export a substantial share of their output. They’re also buying foreign companies that have mostly local -- that is, nondollar -- sales.
Some portfolio managers, however, are hedging their bets against an outright collapse of the greenback by buying gold stocks. “Most tangible assets -- including gold, platinum, copper, oil and real estate -- can be expected to rise in dollar-price terms as the dollar falls,” notes CSFB’s Bonanca.
A weaker currency should give American producers more pricing power both at home and overseas. “This reinforces our generally bright outlook for the U.S. economy,” says Gerard MacDonell, chief fixed-income economist at J.P. Morgan Fleming in New York. He contends that corporations’ ability to raise prices, combined with lower unit-labor costs resulting from productivity gains, will continue to boost U.S. profit margins. “This is favorable for the U.S. stock market,” he adds.
Ultimately, higher producer prices will put upward pressure on inflation and long-term interest rates and will in turn counter the deflationary forces that have been building in the U.S. economy over several years.
U.S. manufacturers and commodity producers that sell their products overseas ought to be the chief beneficiaries of the dollar’s tumble. Robert Unger, manager of the $308 million, Portland, Oregonbased Columbia Strategic Investor Fund (up 34.5 percent in 2003) and the $599 million CMG Strategic Equity Fund (up 33.8 percent), is attempting to capitalize on the dollar’s weakness by increasing investments in Coca-Cola Co., 3M Co. and Estée Lauder Cos. All three earn a good portion of their revenues in euros and yen.
Martin Feldman, an equity analyst at Merrill Lynch Global Securities Research and Economics Group in New York, estimates that the dollar’s roughly 20 percent decline against the euro in 2003 boosted Coca-Cola’s operating profits for the year by about 2 percent and increased its earnings per share by 6 cents. Sixty-two percent of the beverage maker’s sales come from abroad.
U.S. companies that derive more than 60 percent of their revenues from outside the country, as tracked by CSFB, include semiconductor company Advanced Micro Devices (71 percent); capital goods producer AGCO Corp. (71 percent); McDonald’s Corp. (64 percent); and consumer-products company Colgate-Palmolive Co. (62 percent).
In the past year Columbia’s Unger has done well with Dow Chemical Co., which pulls in approximately 50 percent of its revenues from abroad. Another successful pick: Caterpillar, which, with approximately half of its revenues from non-U.S. markets, gained 86 percent. Though he has pared his positions, Unger maintains sizable stakes in both stocks.
He is also optimistic about companies exporting paper and the linerboard used in making boxes. He has positions in Temple-Inland (up 43.9 percent in 2003), Weyerhaeuser Co. (up 34 percent) and International Paper Co. (up 26.6 percent). “These companies lost export share during the 1990s when the dollar was strong,” says Unger, but they should take some back as they gain a pricing edge.
In selecting non-U.S. stocks, many portfolio managers look for companies that draw the bulk of their revenues from their home markets. Kurt Umbarger, portfolio specialist for non-U.S. equities at T. Rowe Price Associates, says that his firm’s non-U.S. core growth portfolios are increasing stakes in European and Asian companies that do little or no business in the U.S.
He recently bought TF1, France’s largest broadcaster, which rakes in 90 percent of its revenues from its home market and the remaining 10 percent from other European countries. The stock was trading at E28.9 in late January, after gaining 8.8 percent last year. TF1 should see growing revenues as the global economic expansion boosts advertising expenditures.
Although the European recovery has been restrained, it should pick up momentum, Umbarger believes. “Many European companies have significant financial leverage, so even a modest pickup can lead to stronger-than-expected corporate earnings growth,” he reasons. Umbarger says the increased sales will encourage corporations to spend more on advertising, boosting broadcaster revenues.
In mid-2003 Umbarger added to his stake in Tokyo-based Seven-Eleven Japan Co., which generates all of its convenience-store revenues in its home market. He bought the stock at an average price of ¥3,000 ($25.50); in mid-January the stock traded at ¥3,274 Umbarger is simultaneously unloading foreign companies with significant export revenues that are hurt by a strong euro. “This is one reason why our stake in Germany is currently a very low 2.5 percent of assets, down from 4 percent at the end of 2001,” he explains. (Germany’s Morgan Stanley Capital International Europe, Australasia and Far East index weighting is 7 percent.)
Umbarger isn’t eliminating companies based solely on their dollar-sensitive revenues. “It’s not that straightforward,” he says. Some European companies, such as London-based advertising conglomerate WPP Group, derive opportunities from the strengthening U.S. economy that outweigh potential currency losses.
Meanwhile, one spirited contingent of investors maintains that a collapsing dollar is not a remote risk. Their main concern is the swollen U.S. current- account deficit, now running at 5 percent of GDP. In his new book, In an Uncertain World, former Treasury secretary and current Citigroup executive committee chairman Robert Rubin warns that the “fiscal morass” of the U.S. economy poses a real risk to the U.S. currency and could trigger a more precipitous dollar decline than most economists expect.
Harvard University professor of economics Kenneth Rogoff, a former International Monetary Fund chief economist, says that the dollar will likely fall by another 15 percent over the next two to four years. He cautions, though, that the risk of a swift, sharp decline cannot be ruled out. “Exchange rates are incredibly volatile and unpredictable,” he says. “The dollar needs to depreciate another 20 to 25 percent over the medium term to be consistent with closing the U.S.'s current-account deficit.” Rogoff adds that efforts by the Chinese and the Japanese to bolster the dollar can’t go on indefinitely.
If the dollar does plummet and inflation soars, gold offers the traditional haven. According to CSFB, gold has a 91 percent negative correlation with the trade-weighted value of the dollar. Some portfolio managers are hedging their bets on a slow dollar swoon with a modest stake in gold and gold-related investments. Declares Jean-Marie Eveillard, manager of the New York based $4.9 billion First Eagle Global fund (up 37.6 percent last year) and the First Eagle Overseas fund (up 41.4 percent): “I am not forecasting a collapse of the dollar. I am simply buying protection against what [economist and investor] Peter Bernstein calls an ‘extreme outcome.’”
