Dollar Bears Mercifully Silent
Howard Simons
11/08/05 - 09:57 AM EST
"The old dollar, she's going down" -- Bill Gates at Davos, January 2005
"In your dreams, Windows-boy" -- Howard Simons
Was there anything more tedious than listening to all those dollar bears a year ago proclaiming that the greenback was not going to be worth the paper it was printed on?
Their arguments were repeated breathlessly, and could usually be summarized as saying Americans were going to get comeuppance for their wicked, wicked ways by seeing the dollar sink, interest rates rise, stocks get pounded and (shudder) their ability to keep on consuming curtailed.
They were wrong then and they would be wrong today if they were so foolish to keep their jaws flapping about our twin budgetary and trade deficits in the face of an upside breakout in the dollar.
But this is not me duplicating Randy Moss' touchdown salute to Green Bay Packers fans (although my
November 2004 observations on stocks and the dollar and my
February 2005 observations on stocks and the trade deficit, both of which contained admonitions to the dollar bears to do their homework, might justify such an end-zone dance). No, this is about questioning whether the dollar rally has room to run and which stock groups would be helped or hurt most thereby.
Money And Curves
Currency markets are not morality plays.
The spot exchange rate reflects, among certain other factors, the relative returns between borrowing in one currency and lending in another. In the money market horizon, the most important for currency traders, these return differentials are determined first and foremost by expected changes in monetary policy between the two countries. We can summarize these expected changes by measuring the shape of the LIBOR curves between six and nine months; three months from now when the typical three-month forward transaction is unwound, today's six-nine month curve will reflect the then-prevailing three-six month conditions.
We can measure the shape of these curves by taking the forward rate between six and nine months -- the rate at which you can lock in borrowing for three months starting six months from now -- and dividing it by the nine-month rate. The more this ratio exceeds 1.00, the looser the monetary policy is expected to be. Critically, these forward-rate ratios are comparable across economies and across interest rate levels.
If we compare these forward rate ratios for the dollar and for the euro as reconstructed back to 1992, we see how U.S. monetary policy was significantly looser than Eurozone monetary policy over that period, as depicted in the pink shaded areas. This included the periods of 1992-1994 and 2001-2005, both of which saw a declining dollar. The periods wherein U.S. monetary policy was tighter, highlighted in orange and with blue rectangles, include late 1995, 1999-2000 and -- you guessed it -- today. All of these periods coincide with dollar strength.
Given the Federal Reserve's rate-hiking stance and the unwillingness of
les poulets at the European Central Bank to follow suit, we have every reason to expect dollar strength to continue.
Winners And Losers
Let's return to an analytic technique first introduced here in
February and used several times since: measuring the relative impact of a market factor on industry groups. Negative numbers in the table below indicate groups benefiting from weakness in that currency against the dollar, while positive numbers indicate groups hurt by weakness in that currency against the dollar. The groups with statistically significant relationships (90% confidence interval) against the large-cap
S&P 500, the mid-cap S&P 400 and the small-cap S&P 600 are displayed for the euro, the Japanese yen and the Canadian dollar.
For the euro, the list of victims is clear. Groups involved with oil and gas, the housing and housing-related financial groups and basic materials groups in steel, aluminum and chemicals all should be hurt by a weaker euro. These industries have the common thread of either being hurt directly by higher interest rates or by having their dividends rendered less attractive by higher interest rates.
Beneficiaries are concentrated in health-care services, pharmaceuticals, specialty retailers and in diversified commercial services. These industries have the common thread of either being export-dependent or having consumers relatively enriched by the stronger dollar. If higher energy costs crimp consumer spending, a stronger dollar restores it somewhat.
Groups hurt by a weaker yen also have a heavy representation in basic materials such as steel, aluminum, gold, specialty chemicals and metals, and mining. Housing and housing-related issues are hurt as well. In all cases, the same comments made for the euro's impact apply.
Groups benefiting from a weaker yen include motorcycle manufacturing, -- that's
Harley-Davidson(HDI Quote) -- pharmaceuticals, health care services, retail and distribution-oriented industries and both distillers and brewers. If you are planning to get drunk and rowdy and ride around on your Hog, now is the time to do it.
Finally, let's take a look at our largest trading partner, Canada, and the impact of its dollar on U.S. stocks. Groups hurt by a weaker Canadian dollar are largely the same as those noted for the euro and yen but include a strong representation in utilities as well.
Beneficiaries of a weaker Canadian dollar overlap those for both the euro and yen, but include a few eyebrow-raisers such as airlines and casinos and gambling as well.
If any of this can be summarized while holding a lit match, it would be this: "A stronger dollar produced by higher interest rates is going to shift market gains from tangible resource issues to consumer-dependent issues."
And if there's any flame left on that match, use it to ignite the collected writings of last year's dollar bears. If that keeps your house warm for a few minutes this winter, their wrongheaded scribbling was not a total waste.
