Is the dollar's comeback for real?

By no coincidence, both commodities, and most of the others, are priced in dollars wherever they trade in the world. Prices go up when the dollar falls, and a strong dollar brings them down.

The dollar bottoms out

The dollar is bouncing off lows it has reached twice before in modern financial history, and it's finding a bottom about where it did both of those times. And it's looking up.

Currency traders are reckoning that the U.S. is more likely to raise interest rates in the coming year than Europe, where they are already much higher. Equity traders -- and U.S. stocks are purchased in dollars -- are reckoning that the U.S. economy, which turned south before the rest of the world's, will turn north before the others as well.

All these trends suggest the dollar, which moves in multiyear cycles, will keep moving up. This is a new cycle that will erase the advantage of foreign stocks.

In fact, this year, as of Aug. 12, core U.S. stock funds -- the Morningstar large-blend category -- are down an average of 11.3%. The corresponding foreign-stock funds are down 17%. This is a case in which diversification hasn't helped.

Muhlenkamp points out that, increasingly, the people buying stocks around the world are the same as those buying in the U.S., from individuals to institutions like pension and hedge funds. "If the owners act the same, the stocks act the same, even if they're in different countries," he notes.

You can't fight the cycle

Advocates of long-term portfolio planning point out that market cycles recur, and the simplest investment strategy -- to diversify broadly, from large to small, domestic to foreign, growth to value -- is also the one that produces the most reliable long-term results. That would argue for standing pat in global funds.

Scott A. Leonard, a financial adviser in Redondo Beach, Calif., says a diversified portfolio is intended to capture outsize results wherever they occur, because predicting where they will occur, and when, is beyond most investors' ability.

"If you feel that you can make these calls, then you don't care about diversification," he says. He argues that making such calls amounts to market timing, and he acknowledges that it can deliver superior results at times -- but not consistently enough for most investors to remain on board.

"To market-time, being right two-thirds of the time is probably doing pretty good," Leonard says. The third of the time you're wrong, however, will shake your confidence, especially if "you" are his client or my reader.

I shade this argument a bit differently. I view market timing as making a decision to be in the market or out of it, with no gray areas. My approach, in contrast, involves adjusting a portfolio moderately to align it with the winds you expect to blow in coming months and years.

Currency valuations are extremely volatile over days and months, but over years they tend to follow strong trends. These cycles are multiyear. The dollar's weakness has lasted more than six years; a multiyear period of strength in the years to come would be routine.

Overseas is still OK

Still, in my own portfolio, I'm not selling foreign stocks out to the bare walls. Foreign small-company stocks and emerging-market stocks have very different characteristics than the S&P 500, and I think each will remain attractive for years, if not decades.

But I plan to cut back selectively on my exposure to large developed-market stocks, which are the staple of international mutual funds. Cut back, not sell out. Even if they don't deliver home runs as they have in the recent past, foreign companies are not just like our own.

"A foreign corporation may be more warmly welcomed in an anti-American Third World country and may be more uninhibited about operating there," says Don Martin, the president of Mayflower Capital in Los Altos, Calif. "French oil companies can drill offshore in Cuba."

There are benefits to foreign investing I don't want to forsake. But tremendous outperformance is a benefit they are not capable of delivering when the dollar is getting stronger. In that regime, investment dollars will be more productive here at home.

At the time of publication, Tim Middleton didn't own or control shares of any company or fund mentioned in this article.

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