True Conspiracy

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Sunday, January 14, 2007

How to Catch a Falling Dollar (and Even Make a Profit)

THE dollar fell against many currencies in 2006, and many Wall Street analysts are predicting more of the same this year.

That needn’t worry investors, who could profit from a continued decline in many ways. But some strategists caution that it may be wiser to try to benefit indirectly from a weaker dollar — by holding stocks or stock funds focused on certain industries and countries — than by betting directly on foreign currencies.

“You’ve got to know your limitations,” said Sam Stovall, the chief investment strategist at Standard & Poor’s. “Unless you make millions of dollars on Wall Street, you probably shouldn’t be speculating in currencies.”

In 2006, the dollar fell 10.2 percent against the euro and 12 percent against the British pound, although it rose 1.1 percent against the Japanese yen.

Mr. Stovall said the best move for most individual investors would be to stock up on the shares of American multinational corporations that earn a lot of their revenues abroad, as well as on foreign stocks. “We feel that many foreign economies are not as far along in their economic cycle, and they have good growth potential now,” he said.

He recommended that individual investors allocate 40 percent of their total portfolios to domestic stocks, 20 percent to foreign stocks, 25 percent to domestic bonds and 15 percent to cash instruments like money market accounts and certificates of deposit.

In terms of domestic stocks, he favors large stocks like those in the S.& P. 500- stock index. On average, the companies in this index earn 41 percent of their revenue in foreign countries.

“If you believe that international economies are going to do fairly well, and the dollar is likely to weaken,” Mr. Stovall said, “then you could get a good bit of tailwind if you transfer those foreign profits back to U.S. dollars.”

But averages can hide wide variances. Some industries represented in the S.& P. 500 draw much more of their revenue abroad than others. Companies in the energy and technology sectors, for example, generate well over half of their sales outside the United States, while the utilities and telecommunications companies in the index produce a vast majority of their revenue at home. For example, the handful of telecommunications providers in the index get just 3 percent of their revenue, on average, in foreign countries.

Stuart A. Schweitzer, global markets strategist at JPMorgan Asset Management, has recommended European stocks for a few years. He said that individual investors should now focus on developed markets — and that if they have made a lot of money in emerging markets funds in recent years, they may want to consider rebalancing their portfolios. “You have to be a little bit concerned that emerging-markets debt and equity may have gotten a bit ahead of themselves,” he said.

Mr. Schweitzer said that any further appreciation of the euro could be modest this year. Still, he added, European stocks were appealing investments for a host of other reasons. He pointed out that the average dividend yield in the S.& P. 500 index was now 1.8 percent, compared with 3.2 percent for the MSCI United Kingdom index and 2.5 percent for the MSCI Europe index, excluding Britain. For Americans investing in Britain or on the continent, a further slide by the dollar against the pound or the euro could bolster those dividend advantages.

“Meanwhile, European companies are cutting costs and restructuring, and that’s starting to show up in their earnings growth,” Mr. Schweitzer said. Earnings per share for European stocks, he said, grew almost twice as fast in the first five years of this decade as they did during the last five years of the 1990s.

On the fixed-income side of their portfolios, some investors may be tempted to profit directly from a falling dollar by buying foreign bonds or CDs. But Martin J. Mauro, the fixed-income strategist at Merrill Lynch, said he didn’t think the time was ripe for investing in foreign bonds.

Interest rates are likely to fall in the United States this year but rise in many other countries, Mr. Mauro said. Bond prices move in the opposite direction of interest rates, so both European and Asian bonds would generally be unattractive for American investors, he said.

Many economists predict that the dollar will fall further against the Japanese yen than it will against the euro — largely because the dollar rose slightly against the yen in 2006. S.& P. forecasts a dollar decline of 6.8 percent against the yen this year; Merrill Lynch sees a decline of 10 percent.

But Mr. Mauro said American investors would be giving up too much yield if they bought Japanese bonds or CDs. Short-term interest rates are less than 1 percent in Japan, versus 5 percent in the United States.

And Mr. Mauro said he expected the dollar to fall by only an additional 1 percent or so against the euro — which he said wouldn’t be quite enough to make up for the yield that Americans would sacrifice by buying European bonds or CDs. One-year government bills in the United States currently pay around 5 percent, versus 3.9 percent in Germany.

For now, he recommends high-quality domestic bonds. He said typical individual investors should put at most 5 percent of their bond portfolios into high-yield bonds, and none into emerging-market debt. Although short-term rates are relatively high, he recommends intermediate maturities — 5 to 15 years — because he expects domestic interest rates to be lower next year.

“If we’re right, and the economy weakens and the Fed cuts rates, then what investors will earn on short-term rates will be a lot less next year,” he said. “It’s a tough move to make now, but they’ll be better off a year from now” if they buy longer-maturity bonds or CDs today.

FINALLY, if investors are really worried about the dollar, Michael Metz, the chief investment strategist at Oppenheimer & Company, advises them to put about 5 percent of their portfolios into gold. He recommends buying the metal through an exchange-traded fund like StreetTracks Gold Shares or the iShares Comex Gold Trust — both of which are backed by bars of gold in a vault. He predicted that gold could rise as much as 20 percent in 2007, to around $750 an ounce.

A falling dollar, Mr. Metz said, may prompt foreign central banks to sell some their dollar reserves to buy gold. He also said that rising incomes across Asia could become a factor. “The great theme of this century,” he said, “will be the enormous transfer of wealth to developing nations, where they have traditionally used gold as a store of value.”

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