Monday, May 14, 2007
Weak dollar props global stocks
“The U.S. dollar has always recovered after sinking as low as it is now; this time it may make new lows,” says Marvin Appel in Systems & Forecasts. Here’s how this can impact investors.
“How do we reconcile the market’s strong performance with the sluggish economic climate? Ultimately, it comes down to valuation. Interest rates are low relative to the earnings yield of stocks. That provides plenty of incentive to borrow in the bond market and use the proceeds to buy shares.
“We are seeing favorable valuation manifest itself in the high level of buyouts and share buybacks. The good times can last for as long as interest rates remain low and earnings remain at current overall levels.
“Meanwhile, international stocks beat the S&P 500 index handily in local currency terms during the past four years, which has been a highly profitable period for stocks. Based on long-term relative strength trends, international stocks remain favored over U.S. stocks.
“I continue to recommend the highly liquid, low expense exchange traded fund, MSCI EAFE Index (ASE: EFA) as the best way for active investors to gain exposure to the international markets.
“The problem for the U.S. dollar is that real short term rates increased from –1.1% to +2.3% in 2005-2006, yet the dollar is as low as it was when real interest rates were negative. If the current weakness in the dollar is the best it can do when real rates are higher than average, the floor will fall out when real rates start to drop again.
“For this reason, the trend favoring international stocks will continue through the rest of the year. When the Fed starts tightening, that will likely prove to be the time when international stocks begin t lag our own.”
posted at 12:10 PM
