In case the surge in the
Dow Jones Industrial Average
has blinded you since President Bush's re-election, it's only my duty to call your attention to the dollar's opposite reaction to the news.
On Nov. 5, the U.S. currency hit an all-time low against the euro. Friday's exchange rate of one euro to $1.294 broke the previous all-time record of $1.2927 set in February 2004.
The euro isn't the only currency rising against a falling dollar. The Australian dollar hit a six-month high against the greenback last week. The Japanese yen is edging toward the highs it set last April. The Canadian dollar has moved to multiyear highs against the U.S. currency: You have to go back 12 years to find the Loonie trading at 83 cents to the U.S. dollar.
It's not just coincidence that these currencies were hitting new highs as the U.S. election drew to a close. Foreign investors, like their U.S. counterparts, have stopped wondering who will win the election and now are focusing on the huge dual U.S. deficits in the federal budget and in the country's trade accounts.
Bush's Flawed Deficit-Reduction Plan
The dollar probably would have come under pressure no matter who won. Both candidates proposed spending programs that would have added hundreds of billions of dollars to the U.S. budget deficit over the next 10 years. But President Bush certainly didn't calm the currency markets in his Nov. 4 press conference when he pledged to make the tax cuts of his first term permanent and to privatize part of Social Security.
Estimates for the cost of those initiatives run into the trillions over 10 years. It's likely that no one trading currencies would have been convinced had Bush pledged fiscal restraint, but the president didn't even throw the markets that bone: The administration's deficit-reduction plan is to hope the economy will grow fast enough to produce extra revenue, even at lower tax rates.
The problem with that plan, the currency markets are quite aware, is that even if higher-than-expected economic growth does work to increase tax revenue and lower the federal budget deficit, those high rates of growth will just increase U.S consumption of imported goods and services. And that will increase the other deficit, the current account deficit of trade and services.
A big part of that deficit is a result of U.S. growth rates: When the U.S. grows faster than the rest of the world, our economy sucks in goods and services from overseas at a faster rate than slower-growing foreign economies increase their demand for our products. It's a trend that has led to ever-higher U.S. trade deficits year after year. And faster growth in the U.S. won't fix that problem. (That's also why the strong job growth reported Friday didn't do much to help the dollar.)
The only solution, the currency markets are convinced, is for the U.S. dollar to sink so that, one, U.S. exports rise as U.S. goods and services get cheaper for buyers who make their purchases in yen, euros or Loonies; and, two, U.S. imports fall as the declining value of the dollar makes foreign goods and services more expensive for U.S. consumers and businesses.
'Declining Dollar' Protection
That logic leads the currency markets to believe that the yen, the Australian dollar, the Canadian dollar and the euro, among other currencies, will continue to climb in value against the dollar, even though they have appreciated in the last 12 months by 5%, 7%, 10% and 13%, respectively.
And that's why I think investors need to add a dose of "declining dollar" protection to their portfolios in the coming months. Three kinds of stocks offer varying degrees of such protection.
Why three kinds of protection? Because at this stage investors can't tell how serious the decline in the dollar will be, either in the magnitude of the drop or in the speed of the decline.
If the drop is restrained in its dimension and relatively gradual in its speed, the
might be able to increase interest rates gradually enough that they don't choke off domestic economic growth and still provide the additional returns that make dollar-denominated investments attractive to overseas investors. In this scenario, the falling dollar is a drag on U.S. bond and equity markets, but it doesn't send them into their own sharp decline.
But I don't think investors should ignore the possibility that a declining U.S. dollar will send some foreign investors into a disorderly retreat from U.S. financial markets. In that case, the price of U.S. equities -- even those of U.S. commodity producers -- will fall, and investors need to look to overseas markets for protection and profits.
And finally, there is an outside possibility that a decline in the U.S. dollar, which is still the currency of international trade and the global reserve currency, will increase the general level of fear and volatility in global financial markets. In that case, I think investors will want to have some of their portfolios in shares of companies that prosper when fear and volatility spike upward.
Three Methods of Protection
Add the stocks of U.S. commodity producers where costs are denominated in dollars but revenue comes largely in non-dollar currencies.
This kind of stock will generate extra sales to overseas customers as a declining dollar makes U.S. products cheaper. It also has the added benefit of increasing dollar earnings as rising non-dollar currencies are translated back into U.S. dollars.
Add the stocks of commodity producers in strong-currency economies.
The value of these companies' assets will climb in dollar terms as the dollar declines and as their own currencies appreciate. U.S. investors will be giving up some of the kick from the U.S.-based companies in my first group, but they will be adding protection from a decline in equity values in U.S. markets that a falling U.S. dollar might produce. My choices for strong-currency economies are Australia and Canada, both economies with heavy exposure to the export of commodities such as coal, iron ore, nickel, timber and oil.
Examples of specific stocks to own are
Add shares of gold producers.
Gold is the refuge of choice for many investors when market turbulence increases. Anything that increases volatility drives up the price of gold and gold shares. I don't think it's out of line to imagine that questions about the world's reserve currency might increase worry and volatility.
( PDG) and
A final word on timing: Don't buy these stocks now. Stocks like these have had big run-ups this year. At current prices, I think investors will be paying too much for the kind of insurance they offer. You should get a buying opportunity sometime after the turn of the year. Why?
First, the rotation that's now happening as U.S. stocks rally on relief that someone was elected president in an orderly manner, on falling oil prices and on end-of-the-year bets by portfolio managers who have lagged the market all year will send money from the commodity stocks I've mentioned into growth and momentum stocks. That should produce a modest pullback in the price of this kind of protection.
Second, the continued efforts of the Chinese government to slow the growth rate of its economy will lead some investors to sell these commodity stocks. The more stories you see about rising Chinese interest rates or about the possibility that China will let its currency appreciate against the dollar, the more likely it is that the commodity stocks fueled by Chinese demand will fall. Chinese demand isn't going away in the long term, but in the short term, I think investors can look for some profit-taking in the sector on prospects for slower Chinese growth.
So enjoy the rally that's now unfolding, take some profits as your stocks hit their target prices or as we move into January, and put a portion into declining-dollar protection stocks like these.
They don't need to dominate your portfolio any more than you need to spend all of your monthly paycheck on insurance premiums. But this is a good time to buy some protection against what seems like a real risk in the months and years ahead.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Newmont Mining and Placer Dome. He does not own short positions in any stock mentioned in this column. Email Jubak at