The Dollar As an Investment Prognosticator

In late 2007 with a weak dollar it took roughly $1.57 to buy a euro. Now with a stronger dollar, on January 11, 2015, it only took $1.18 to buy one euro ($1=.84€). Economic trends are cyclical and we are in a cycle of dollar strengthening as foreign central banks weaken currencies to attack economic ills. What does that tell you as an investor?

As a dedicated traveler, this writer recalls the pain when the euro was north of $1.50 U.S. Europe was expensive! U.S. national parks and ski resorts were full of European tourists as America, even with airfare thrown in, was on sale. Now the dollar buys more all over the world, good news if you are planning a bucket list trip abroad. Pundits see the euro dropping further. Goldman Sachs predicts parity to the dollar by 2017, a level not seen since 2002 when the euro was introduced. What’s behind these moves?

The global credit crunch induced recession and market crash of 2008 introduced a new term to investors—quantitative easing (QE). In response to the financial crisis, Federal Reserve Bank Chairman Ben Bernanke set out to depress interest rates and “create money” by buying mortgage bonds and government bonds. By July 2012, the benchmark 10-year Treasury note rate hit a multi-decade low of 1.379%. Lower interest rates decrease the cost of government and consumer borrowing and supposedly prods businesses and households to invest. QE can boost asset prices like stocks and real estate, something Bernanke wanted to bolster confidence.

When central banks engage in QE and other forms of stimulus, including money creation, currency weakens. The U.S. is ending QE, signaling that policy will “return to normal at some point,” perhaps this year with an increase in interest rates. The 10-year Treasury rate was 1.975% on January 9, 2015. Kiplinger sees the 10-year Treasury rate at 3.20% by yearend 2015.

Central banks also use QE to boost inflationary expectations. The theory is that if consumers expect money to be worth less in the future, they will buy now and boost demand. Low interest rates penalize savers and reward borrowers and spenders. The U.S. Fed has set 2% as an inflation target. Kiplinger forecasts inflation at 1.9% by the end of 2015, with GDP growth at 3% annually.

The current Fed Chairwoman Janet Yellen will not surprise markets with rapid interest rate boosts in 2015. Trained as a labor economist, she watches wages and unemployment and underemployment as an indicator. Job numbers are improving but wage growth remains weak. Combined with lower gas prices, consumer spending should get a boost. But with too many people in part-time jobs and a dearth of full-time opportunities, labor force participation rates remain low at levels not seen since the late 1970s, increasing Ms. Yellen’s cautious approach.

On the surface, America is the shining star in the global economic sky, reflected in rising stock prices. Yet, when stimulus is applied in other economies, that signals the beginning of a recovery cycle. Investors who bought stock and selected real estate in 2009-2011 as the U.S. central bank applied stimulus were financially prescient and have profited. Increased volatility notwithstanding, don’t abandon global asset allocations. As bankers in Europe, Japan, China, and elsewhere depreciate currency and apply stimulus, sharp-eyed money managers are trolling for bargains. Bargain seekers also are eying depressed natural resource stocks relative to the next cycle. Money goes where it is best treated and the U.S. stock market still is the deepest and most liquid on the planet.

Even with wage growth, inflation is not likely to accelerate near term over Federal Reserve targets. With bargain conscious consumers armed with smartphones trolling for bargains, it is difficult for companies to raise prices. Black Friday saw increased competition from Cyber Monday!

Lending has been anemic in the U.S. but that is changing. Commercial and industrial lending is picking up—a positive! In short, equity investors should retain a good balance between American and international equities. And plan that long-delayed trip to Europe. A good house wine in France (cuvée du patron), Italy (vino della casa), or Spain (vino de la casa), is a much better deal than it was not long ago. Santé!

Lewis Walker is President of Walker Capital Management, LLC. Certain advisory services offered through The Strategic Financial Alliance, Inc. (SFA). Lewis Walker is a registered representative of SFA which is otherwise unaffiliated with Walker Capital Management, LLC. lewisw@theinvestmentcoach.com