vaughnwoods

What’s going on with the dollar and what does it have to do with a stock market rebound? Here’s the short version:
The dollar is weak and, in the near term, getting weaker, but that could all change soon. Relative to the euro, the pound sterling and other word currencies, the dollar has been dropping for six-plus years. However, like the stock market, the dollar has bull and bear markets. Dollar bear markets last about 7 to 10 years. The 7th anniversary of the current dollar bear market is in February of 2009.

Currently the dollar only buys just over half a pound sterling and approximately two-thirds of a euro. Yet analysts believe the dollar will continue to weaken until the European Central Bank (ECB) cuts rates. Some analysts say the euro may be worth $1.65-$1.70 before the ECB begins cutting rates and OPEC nations revalue their currencies relative to the dollar. Credit Suisse analysts expect the ECB to cut rates in July. Meanwhile, OPEC will continue experiencing inflationary pressures due to high oil prices and falling U.S. interest rates, until they revalue their currencies upward against the dollar. The easiest ways to lower inflation in OPEC and China are to accelerate currency adjustments and sell dollars. Inflation in Kuwait and Saudi Arabia currently stands at approximately 12% and 7% respectively. Selling dollars may cause a short-term period of self-reinforcing weakness representing the final leg down in the dollar bear market. We may be approaching that phase now.

Together, OPEC and China hold some four trillion dollars in reserves. Moreover, foreigners own more than 50% of US Treasury bonds. This figure represents US net foreign liabilities of nearly a fifth of GDP. Thus, the weaker the dollar, the more indebted the US becomes. Once again, the weaker dollar may force the ECB to cut rates. Historically, once the ECB joins with the Federal Reserve Board in cutting rates, the US stock markets turn upward. Given a July ECB rate cut, as predicted by Credit Suisse analysts, the US stock market could see a bottoming out or a rebound by September. This of course would give the winning presidential candidate a convenient opportunity to claim credit for the stock market upswing.

Credit Suisse analysts report that on a twelve-month view, they “feel very convinced” that the dollar will be stronger against the euro and, in particular, the pound sterling for seven main reasons: (1) The dollar is cheap. They think the dollar is worth $.80 against the euro. (2) The dollar is cheap relative to a Producer Price Index Model followed by Credit Suisse. (3) The US current account deficit is improving very quickly, in that export growth exceeds import growth by 7% (4) The cyclical bear market in the dollar, now approaching its seventh year, appears to be ending. (5) European banks, which are more leveraged than US banks, are entering a credit crisis. (6) As investors realize OPEC and China are accelerating revalues against the dollar, it will take pressure off the euro to appreciate. (7) Once the ECB starts cutting rates, the international community will recognize the Europeans need to play catch-up as US rates are currently 2.5% below European rates.

Clearly, until the dollar reaches a bull cycle high again, perhaps in the year 2016 or later, stock market winners will be those companies whose costs are tied to the dollar and whose revenues are derived from stronger foreign currencies.

Contact us to learn more about working with Vaughn Woods Financial Group.

Best Regards,

Vaughn L. Woods, CFP®, M.B.A.

*Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter may not reflect the views off Delta Equity Services Corp. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice.

**Marketedge.com, Pershing NetExchange Pro, Bloomberg,
***Equity Research, Investment Strategy, Credit Suisse, March18, 2008