Rising on a Falling Dollar


By Eric Wahlgren Every new day it seems, the once-strong U.S. dollar is turning into a bigger weakling. On Nov. 19, the world's most used currency got pounded to a record low against the Euro and three-year low against the yen. Why has the greenback fallen so hard? Concerns about U.S. fiscal and trade policy, and global security are largely to blame. What's worrying to equity investors is that the dollar's slide is starting to have an effect on the stock market as foreign investors begin to question the value of holding so many U.S. dollar-denominated assets that are declining in value.

Still, what may be bad for the overall market could be good for certain stocks, says Sarat Sethi, a partner and portfolio manager at Douglas C. Lane & Associates, a New York investment advisory firm that manages some $1.2 billion in assets. (The firm creates baskets of stocks for clients who invest a minimum of $500,000.) With the dollar so depressed, Sethi has been focusing on helping clients invest in U.S. multinationals that are benefiting from this situation. These outfits include basic-materials companies -- the firm's accounts have a 15% to 20% stake in the sector on average, vs. 3% for the benchmark Standard & Poor's 500-stock index.

The international perspective comes naturally for Sethi. An American with an MBA from Harvard University, he was born in India and once worked in Australia as an mergers and acquisitions banker with JP Morgan. In a recent chat with BusinessWeek Online reporter Eric Wahlgren, Sethi discussed the currency situation and what stocks stand to gain from it. Edited excerpts of their conversation follow:

Q: For starters, why does the greenback keep falling?

A: There is a concern about the U.S. trade deficit. Over time, that puts pressure on the dollar since we have more dollars being used to buy foreign-made good and services than are coming in to buy U.S.-made goods.

And then there's the budget deficit. The government is spending a lot more money than it takes in. Foreigners own a lot of U.S. securities and bonds, and as the dollar has devalued, the value of their bond investments has dropped. That drives them to start selling their investments, which puts further pressure on the dollar. The dollar has weakened about 20% against the Euro over the last year.

Q: Is a weak dollar bad for the stock market?

A: Foreigners, who own a disproportionate share of U.S. investments, are finding that the value of those investments is dropping as the dollar gets weaker. Meantime, their own currencies are getting stronger, making the value of [non-U.S.] investments look more attractive. Over time, that could have an impact on foreigners holding U.S. securities and could cause them to sell.

Q: Don't some stocks stand to benefit?

A: In the late 1990s as the dollar got stronger, companies that had overseas earnings, U.S. multinationals for instance, were getting hurt. When you translated the weaker foreign currencies back into dollars, you had less to show for your efforts.

Now you have several forces at work as the dollar weakens. Our exports are getting cheaper. We can export to countries that we couldn't export to before because our prices are more competitive, especially in the commodities areas, such as paper and chemicals.

Conversely, imports are getting more expensive. As a result, U.S. companies become more competitive at home. Finally, companies that have overseas earnings, such as McDonald's (MCD), benefit when they translate back into U.S. dollars.

Q: What companies could gain from today's currency situation?

A: First of all, it's important to point out that what you want to see is a steady decline in the dollar. You don't want fast movements that could unravel the financial markets. You don't want to see unnecessary volatility.

As far as stocks that can benefit, a specialty-chemicals company like Dow Chemical (DOW), which has over 50% of its earnings overseas, will do well. International Paper (IP) could benefit by being able to export more. McDonald's, of course, has a majority of its earnings overseas. So does Coca-Cola (KO). Eastman Chemical (EMN) has more than a third of its earnings overseas.

Coming out of a recession, commodities companies like Dow and Eastman Chemical have a lot of operating leverage. They have become leaner. As the economy continues to improve, and they generate more revenues, more of that will end up on the bottom line because of greater operating efficiencies.

Q: What about technology companies? Don't they have a lot of overseas exposure?

A: Tech firms like Cisco (CSCO), as more of their earnings are generated overseas, will also benefit from the translation effect. The thing is, tech companies are played by investors more on specific technologies and their core competencies.

In all companies, the key thing to remember is that if their underlying fundamentals aren't improving or aren't sustainable, all you are going to benefit from is the currency.

Q: Any other companies that stand to benefit from a weak dollar?

A: Multinational industrials will also do well because they are diversified and they have a lot of earnings overseas. Consumer-staples companies that have strong global brands, such as Procter & Gamble (PG) will also benefit.

Q: What's going to happen to the dollar in the future?

A: I don't see it snapping back in the short or medium term. In fact, in the next few months, we feel it's going to get weaker. Until the U.S. starts reducing the size of the trade and budget deficits, we will have sustained pressure on the dollar. Wahlgren covers financial markets for Business Week Online in New York


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