But in trying to buy time to solve that problem, the Fed has accelerated the plunge in the U.S. dollar. Several factors have been driving the dollar down:
- A huge U.S. trade deficit has caused overseas investors to hold more and more dollars in recent years.
- U.S. interest rates held steady while they were still headed up in the European Union, Canada, Australia and the United Kingdom, meaning that overseas investors were getting paid a smaller premium to hold that rising supply of dollars. More recently, the Federal Reserve began cutting rates while our trading partners were still increasing theirs or holding them steady.
- The U.S. stock market hit the skids.
So now overseas investors are faced with unattractively low interest rates, unattractively low (or negative) returns on stocks and a falling dollar that means they will lose money in their home currencies even if U.S. stocks hold steady.
Scenarios for a turnaroundAn increasing number of overseas investors are asking themselves: Who needs this? As a result, the global search for alternatives to dollar-denominated investments is accelerating. Buyers are looking to stocks in China, India and Brazil; real estate in Hong Kong; Australian dollars and Icelandic krónur; gold and silver; and commodities and commodity producers. Anything but greenbacks.
What could turn this around and put an end to the dollar's plunge?
- An increase in U.S. interest rates? That's off the table as long as the U.S. financial sector is in turmoil, as long as the U.S. housing industry is in the dumps and as long as the U.S. economy is in danger of slowing -- unless you think the Federal Reserve would like to start a recession in an election year.
- An increase in returns from U.S. stocks and bonds? That's not likely as long as the U.S. financial sector is in turmoil, as long as the dollar is falling and as long as investors fear that the U.S. economy might be slowing.
- Lower risk in U.S. stocks and bonds? It's not in the cards as long as U.S. financial stocks are in danger of imploding.
- Lower returns in competing overseas markets? Not yet, anyway. Markets in China and the rest of the emerging world are racing ahead. But it's quite possible in the longer run if the economies of China, India and elsewhere still catch colds when the U.S. economy sneezes (new theories that say otherwise might be wishful thinking).
I think that leaves dollar-denominated investors -- that means folks like me who live in the United States and collect paychecks in dollars -- stuck in the short run. Turmoil in the financial sector leads to a falling U.S. stock market and a weakening U.S. economy, leading to interest-rate cuts by the Federal Reserve, leading to a weaker U.S. dollar, leading overseas investors to eschew investments in dollar-denominated assets (and dollars), leading to a falling U.S. stock market and so on.
5 tips for investorsSo what's the poor dollar-denominated investor to do? I've got five suggestions:
- Think like an overseas investor and put your money into hard assets or strong currency assets. In the first group: gold, silver, iron mines, oil, etc. In the second group: Canadian and Australian stocks, and Indian and Chinese real estate (if you can find some that isn't horribly overpriced). I'll give you names of stocks in these two groups in two upcoming columns.
- Think leverage from a weak dollar. A weak dollar gives U.S. exporters a huge pricing advantage over strong-currency competitors. If exports are enough of a company's revenues -- or if the company is in a position to expand its exports rapidly -- the gains to the company could be enough to make up for weakness in the U.S. economy and for overseas reluctance to buy dollar-denominated equities. I'll be doing a column on stocks that fit this bill soon.
- Think long term. I think we've got a way to go before the U.S. dollar stabilizes. When it does, it's not likely to bounce back quickly. We could be in for a good long period when the dollar is stable at a relatively low exchange rate and profits of U.S. exporters soar. As overseas investors discover that dollar-aided profit boom, the U.S. stock market will start to outperform again, attracting more overseas investment and resulting in more outperformance. Virtuous cycles sometimes follow hard on the heels of vicious cycles. A future column will look at companies that are likely to be able to lock in the competitive advantage that a weak dollar temporarily gives them.
- Identify what farsighted overseas investors will be buying here. A cheap dollar gives strong-currency CEOs and investors a chance to buy U.S. assets at what are, to them, bargain prices. Those prices are apt to result in windfall returns to dollar-denominated investors willing to buy bargain-priced but out-of-favor U.S. assets. My next column will look for opportunities like this.
- And finally, stay calm. Many of us have been looking for a 10% correction in the market as a whole for months now. I've argued that stocks have moved up too far too fast from the August low and that we need some short-term pain to set up the market for the next stage of its rally. On Nov. 8, the Standard & Poor's 500 Index ($INX) finished 6% off its Oct. 9 closing high. It seems silly to panic when we're getting exactly the medicine that the market needs.