The U.S. dollar is making headlines. As of early January, the battered greenback was down more than 32% from its peak in early 2002 against the euro and roughly 20% against the Japanese yen.

With the U.S. running a huge trade deficit and huge budget deficit, many foreign investors are convinced that the U.S. government wants the dollar to continue to fall.

The outlook for the dollar is so bad that Warren Buffett, for the first time in his investing life, has bought foreign currencies. Buffett notes that he's been wrong before in his worries about the consequences of rising U.S. deficits, but, as he told Fortune magazine in late 2003, "this time I'm backing it with Berkshire Hathaway's money."

I'd agree it's difficult to see the dollar doing anything but slipping further over the next year or more, and in the long run, a weaker dollar isn't good news for the U.S. economy or for U.S. consumers. A weaker dollar puts increasing pressure on the Federal Reserve to raise interest rates, because, as a debtor country, the U.S. has to continue to attract huge amounts of foreign capital. Consumers face higher prices for foreign imports, and besides taking a bite directly out of our wallets, rising prices for imports increase the odds that inflation will creep higher.

But that's in general and in the long run. In particular and in the short run, investors can profit from a falling dollar -- and that's without speculating in currency futures or buying a truckload of gold.

A few sectors of the economy will make unexpected gains over the next year or two from a falling dollar. By buying good old common stocks in these sectors, you can make a profit.

The auto-supply sector is likely to be a prime beneficiary of a falling dollar. The stocks in this sector I believe should be on your radar include:


7 Big Auto-Parts Makers to Consider
Company Primary business
BorgWarner (BWA) Powertrains, transmissions
Dana (DCN) Axles, drive shafts
Dura Automotive (DRRA) Driver control systems
Lear (LEA) Interior systems and components
Magna International (MGA) Interior systems, including instrument and door panels
Superior Industries International (SUP) Automotive wheels and suspensions
Tower Automotive (TWR) Structural components, suspension systems

I'm buying one, BorgWarner. But once you understand how a weak dollar can lead to extra profits for companies in this sector -- and for the investors that hold their shares -- you can use the same logic to find other sectors offering the same kinds of opportunity.

The Dollar's Decline May Not Be That Bad

To find a falling dollar profit play, you have to start with the details of the dollar's decline.

Yes, the dollar is down big against the euro and the yen, but if you compare the dollar against what is called a trade-weighted basket of currencies, the picture looks very, very different.

According to the Fed, the dollar has declined just 12% since early 2002 against a basket of the currencies of our important trading partners. (Each currency in the basket is weighted by the amount of trade that country conducts with the U.S.) By that yardstick, the Fed says the dollar is still about 7% above its average value in the 1990s and about 17% above the trade-weighted low it hit in the second quarter of 1995.

Why the huge difference? Two reasons:

  • China. That country, which has become a huge U.S. trading partner, pegs its currency, the yuan, to the value of the dollar. China ran a $120 billion trade surplus with the U.S. in the most recently reported 12-month period, and during that period, the value of the yuan remained steady against the dollar. Other Asian export economies also peg their currencies to the dollar.
  • Europe.The European Central Bank has kept its focus on fighting inflation instead of cutting interest rates to boost economic growth, as the Fed has done. At its meeting on Jan. 8, the bank left its short-term interest rate at 2%. That left interest rates twice as high as the Fed's current 1% target. That differential has helped fuel the euro's climb against the dollar: An investor in euro-denominated assets gets an appreciating currency and more interest.
  • Who Gets Squeezed

    These details of the dollar's decline show exactly who is getting squeezed most painfully. The Europeans face seeing their exports drop as they become more expensive to U.S. consumers. They face increasing cost competition from China as Chinese exports become cheaper with every drop in the value of the U.S. dollar, thanks to the yuan/dollar peg. European exporters even suffer a disadvantage against Japanese competitors, since that country spent more than $200 billion in 2003 buying dollars with yen to slow the appreciation of the Japanese currency. And many Europeans think the problem will get worse before it gets better. With the European Central Bank focused on inflation and the huge budget deficits in France, Germany and Italy, the betting is that European interest rates will rise in 2004. Perhaps, as Goldman Sachs has argued in the case of the bank's key short-term interest rate, to as much as 2.75% from 2% now. That likely would push the value of the euro even higher against the dollar.

    Fearing a rising euro, many European companies have begun to seek ways to hedge. In the electronics sector, for example, that means moving production to China or buying more components from Chinese companies, because those products are priced in the dollar-pegged yuan. For other European companies, especially those already doing big sales in the U.S. and that already have manufacturing plants and supplier relationships here, it means increasing production in the U.S. or purchasing more components from U.S. suppliers. That's an especially compelling option in industries where European companies face strong competition from Japanese manufacturers with substantially larger U.S.-based production.

    In the auto industry, Europe's Volkswagen ( VLKAY) saw the rise of the dollar lop more than 1 billion euros, or about $1.3 billion, off of sales in 2003, and that was despite the company's use of derivatives to hedge about 40% of its dollar exposure. As a response, the company is shifting production of its Jetta and Bora models from Germany to Mexico and Brazil, whose currencies more closely track the dollar and where many deals are priced in dollars. In 2005, the company will shift production of its Golf models sold in the U.S. to Brazil as well.

    DaimlerChrysler ( DCX) will do even more. The company will build its new Mercedes family car at its Alabama plant, investing $600 million for expansion, and export some of the production back to Europe. Saab, the Swedish unit of General Motors ( GM), will soon start to build an SUV at one of its parent's U.S. plants.

    And most importantly for investors, these companies will be increasing the share of U.S.-made components used in their cars.

    Japanese automakers, which already produce more cars in North America than their European rivals, are also stepping up their U.S. production and sourcing. Toyota Motor ( TM), which produced 1.1 million cars in North America last year, compared with about 90,000 for DaimlerChrysler's Mercedes division, plans to open a sixth North American plant in Texas next year.

    With plans and plants announced for 2005 and 2006, it seems that none of these European and Japanese carmakers is expecting the dollar to turn around soon. Economists estimate that the dollar needs to fall by an additional 15% to 20% in trade-weighted value to significantly reduce the U.S. trade deficit.

    The winners in all this are the U.S. auto-parts supply companies, which have spent the last decade turning themselves into the world's low-cost suppliers. Now they are about to get a chunk of new business that isn't about to go away soon and will likely grow larger if the dollar declines further. These companies thus get a double edge from a falling dollar because:

  • They can sell more overseas because their dollar-denominated product becomes cheaper vs. those of, say, European or Japanese suppliers every time the dollar takes a knock.
  • They will pick up global market share as overseas carmakers look to offset the falling dollar by increasing the dollar-based content of their cars.
  • I think all the North American auto-parts suppliers should benefit from the efforts of European and Japanese automakers to hedge their exposure to a weaker dollar. But a couple of companies stand out as best positioned to benefit from the trend: BorgWarner ( BWA) and Magna International ( MGA).

    My top pick is BorgWarner, because the company has been so aggressive about growing its business with foreign automakers. Volkswagen, for example, uses its DualTronic manual-automatic transmission, and the company has turned Honda Motor ( HMC) into a big customer. Top customer Ford ( F) is just 25% of sales.

    Magna International could come out as a big winner if its partnership with BMW pans out, but it carries a fair amount of risk. Lear has made itself over into a global supplier of increasingly complete automotive interiors. But too much of the company's business is with the U.S. Big Three for it to fit with this weak-dollar theme. I like Dana as a turnaround story that's taking off, but the company is heavily tilted toward trucks and light trucks.







    What other industries or sectors are worth a look? One that comes to mind is the oil drilling and service sector, where a weak dollar makes the dollar-denominated cost/benefit ratio for increasing drilling look very attractive to the big oil producers right now.

    Let me know by email if you come up with other sectors likely to be weak-dollar winners, and I'll share your suggestions with readers in updates to this column.

    Changes to Jubak's Picks

    Buying BorgWarner: In the last six years, BorgWarner has turned itself into an international auto parts supplier from pretty much a domestic U.S. only business. That positions the company to reap the rewards of a falling dollar. In 1997, about 85% of BorgWarner's business came from the Big Three U.S. automakers; in 2002 the U.S. share of the company's business had fallen to 68%. The company has also gone through an internal reinvention by shedding commodity businesses to focus on developing proprietary powertrain systems. With domestic car inventories dropping to normal levels in December after November's bloat and a falling dollar leading to increases in BorgWarner's sales in Europe and to U.S. factories of overseas car companies, I think 2004 earnings growth is likely to top the 13% now expected by Wall Street analysts. I'm adding the shares to Jubak's Picks with an October 2004 target price of $110 a share.

    At the time of publication, Jim Jubak owned or controlled shares in none of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column. Email Jubak at jjmail@microsoft.com.

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