The buck is burning. That's great for stocks -- for now
Or so say the dollar doubters. Are they right? Only time will tell, but the foundering dollar is having a very salutary effect on equities -- at least for now.
The U.S. Dollar Index, which measures the greenback against a basket of six major currencies (you can see the related exchange-traded fund here UUP), fell to a one year low ahead of Wednesday's Federal Reserve meeting. Little wonder there. As long as the Fed continues to print money through a zero-interest-rate policy and so-called quantitative easing, the U.S. continues to run a big trade deficit, and other nations move their foreign exchange reserves out of dollars, the buck has no place to go but down.
That's great news for gold bugs and commodity traders. Anything denominated in dollars, like gold and oil, goes up when the greenback falls.
Of more importance to retail investors and their 401(k)s is that a soft dollar boosts stock prices. There's a simple explanation for that: 50 percent of the S&P 500's revenues and 40 percent of its earnings come from foreign sources -- so a weak dollar bodes well for both top- and bottom-line corporate performance.
In other words, it's no coincidence that from the March market bottom, equities have soared nearly 60 percent, while the dollar has crashed 15 percent.
Of longer-term concern is that current Fed policy will turn into a full-blown currency crisis. Keith McCullough, chief executive of ResearchEdge, a New Haven, Conn., research firm, says the Fed is leading us into stagflation in the not-too-distant future -- putting equities in a very bad way, indeed. Steve Scruggs, portfolio manager of Queens Road Small Cap Value Fund (QRSVX), thinks the dollar's days as the world's reserve currency are numbered -- meaning the sun may be setting on the American Century.
But David Wyss, chief economist at Standard & Poor's, says all the hand-wringing over the dollar is greatly overblown. True, the dollar has cratered since March, but year-over year it has barely budged, he points out. (It's off one percent.)
Furthermore, worries about inflation or stagflation are premature at this point. "There are good things about a weak currency," Wyss says. "Most countries try to keep their currencies weak to boost exports. We need jobs right now, which means we need more exports."
The market's mighty rally on dollar weakness isn't an intentional Fed policy, says Wyss, no matter what conspiracy theorists say about The Plunge Protection Team. "The market's move up is an unintended consequence of the Fed's reflation policy, but it's not necessarily an unwelcome one," he says.
That's reassuring -- to a degree. Just bear in mind that the reflation trade can't last forever. Eventually the Fed will hike rates and the market won't like it one bit. There's also the possibility in the shorter term that the Fed will drain $1 trillion from the money supply. Either way, what the reflation trade giveth, it can just as easily taketh away.
Let us not forget that as wonderful as a weak dollar has been for equities, there's no substitute for real, sustainable corporate profit growth. Take out the effects of currency exchange and suddenly corporate earnings won't look so pretty.
But, hey, that's something for the market to dither about later.