After three years of honey-roasted declines, it's hard to feel any pity for the bears. Still, market skeptics find themselves in something of a quandary these days. Major averages have rallied sharply since mid-March despite little evidence of economic resurgence and a host of potential negatives, including persistent weakness in the dollar.

The dollar's recent downturn has done nothing to stem rallies in equities and Treasuries, i.e. the very assets it is supposed to hurt. The dollar's relatively controlled decline, thus far, plus some genuinely positive effects (and generally positive spin) has ameliorated any potential negative side-effects. But that doesn't mean the dangers of a declining dollar have been removed. Hardcore bears say it's only a matter of time before a (rude) awakening occurs for a currently overly complacent Wall Street.

Going back to the boom era, a dollar doomsday has been a frequently cited scenario of naysayers, as follows: Unwilling to support the U.S.'s huge current account deficit (and now federal budget deficit), foreigners start liquidating their dollar-denominated assets, putting downward pressure on the dollar, stocks and Treasuries. Weakness in the dollar triggers a self-replicating cycle of selling, ultimately resulting in dramatically lower asset prices and sharply higher interest rates, choking off U.S. economic growth. (Just add water, bake at 350 degrees for 20 minutes and ta-da, economic apocalypse.)

"We've said many times that you can't have a current account and/or budget deficit as onerous as we have right now without major consequences," said Charlie Minter, the oft-bearish co-manager at Comstock Partners, a Yardley, Pa.-based money management firm.

Foreign holdings of U.S. financial assets totaled nearly $8 trillion at the end of 2002, including $3.4 trillion of fixed-income assets and $1.3 trillion of publicly traded equities, according to the Federal Reserve. The potential risk posed by a mass exodus of foreigners "actually exceeds the risk of public liquidation" of mutual funds, Minter warned.

Such concerns are widely held in the Cassandra community, which excitedly notes inflows of foreign capital slowed for the three months ended February, the most recent data from the Treasury Department. However, while the dollar is down by more than 9% vs. the euro this year and 3.7% vs. a basket of major currencies, stock proxies are uniformly higher year to date, with the S&P 500 up 7.1%. Meanwhile, yields on the benchmark 10-year Treasury, which move in the opposite direction of its price, have fallen 20 basis points since Jan. 1.

It's All Good, Dollar Style

The dollar's recent weakness hasn't been viewed more negatively because "the euro had its collapse and that's been reversed," said Minter, noting the euro has turned around the severe decline it suffered almost immediately after its introduction in January 1998 until bottoming at under 84 cents in late October 2000. "That's all that's happened."

In addition, the fall in the greenback has been reasonable and orderly, thus far. As long as the velocity of the dollar's decline remains contained, currency watchers say a more precipitous decline is unlikely. And if the diplomatic brouhaha over Iraq followed by a string of recent off-the-cuff comments by Treasury Secretary John Snow hasn't caused a more ferocious run on the buck, one wonders what will.

Furthermore, "so far, the stock market views the decline in the dollar in a positive vein -- that it's going to help profits of American multinationals, help exports, etc.," observed Jean-Marie Eveillard, manager of the $2.6 billion ( SGENX) First Eagle Global and $200 million ( SGGDX) First Eagle Gold funds. (Indeed, much of the press coverage has taken this positive slant, notably, separate features in Tuesday's The New York Times and The Wall Street Journal.)

Although the U.S. trade deficit widened to a bigger-than-expected $43.5 billion in March, exports were a bright spot, rising 0.6% to $82.3 billion. Meanwhile, U.S. corporations generated 22% of their sales overseas in 2002, according to Smith Barney's institutional equity strategy group, and the first-quarter results of firms such as IBM ( IBM), DuPont ( DD) and Procter & Gamble ( PG) were aided by the improved currency translations brought about by the weakened dollar.

Frank Holmes, chairman and CEO of U.S. Global Advisors, a San Antonio-based firm with about $1.1 billion under management, said a weaker dollar helps make products offered by multinationals such as Boeing ( BA), General Electric ( GE) and Microsoft ( MSFT) more competitive vs. their international rivals -- where such competition exists. Thus, the stocks of same -- U.S. Global is long all three -- become more attractive.

"In previous cycles, whenever the Treasury bill's yield has been below the inflation rate and deficit spending puts pressure on the currency, it makes gold very attractive and also changes the leadership of the S&P 500," Holmes said. "Leadership rotation takes place into companies who are exporting because a lower dollar makes us more price competitive."

Information technology derived 51.3% of its sales overseas in the latest fiscal year, according to Smith Barney, the second-highest (behind energy) among S&P sectors. The preponderance of overseas sales is one reason cited for the outperformance of the Nasdaq Composite, which was up 15.3% year to date heading into Wednesday's session.

Meanwhile, Treasuries have overcome dollar weakness thanks to myriad factors, including heightened geopolitical concerns and, more recently, renewed worries about deflation. As discussed here , some believe the Federal Reserve is going to combat deflationary pressures by buying long-dated Treasuries, which injects liquidity directly into the financial system.

The Yellow and The Green

While neither is a "gold bug" or hard-core bear, Eveillard and Holmes each have previously expressed optimism about gold due, in part, to concerns about a weakening dollar. Because gold is priced in dollars, it generally trades inversely to the currency. True to form, gold has risen from about $320 per ounce to nearly $350 since early April, in concert with the dollar's recent downward acceleration.

Holmes remains bullish on gold but believes current levels represent fair value, based on money supply and interest rates, among other factors. Furthermore, he's mostly upbeat on gold stocks because of increased demand (notably from China) at a time of shrinking mine development and rising environmental obstacles to new exploration.

Eveillard, meanwhile, sees gold as an "insurance policy" against the "enormous imbalances" created in the bubble era.

"There is the vague threat that the dollar will weaken sharply from where it is already," he said, admitting what would precipitate such an upheaval is unclear. "Maybe the odds are low, but the consequences to my equity portfolio is so severe, I want that insurance" provided by gold and related shares; he believes they should be 5% to 10% of portfolios.

Finally, Eveillard agreed actions and comments by the Fed -- most notably the now infamous "printing press" speech by Fed governor Ben Bernanke last November -- as well as more recent body language from the European Central Bank, suggest "the U.S. may have started a cycle of competitive devaluations."

Such a scenario, should it come to pass, would very likely be wholly negative for all financial assets, much to the delight of the now-suffering bears.
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to Aaron L. Task.

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