IMPACT OF THE FALLING DOLLAR : Turmoil in the Markets : How Many Bears Will a Weakening Dollar Buy?
The calendar says it’s late June, but on Wall Street it feels disturbingly like late March.
The dollar’s sudden plunge has pulled U.S. stock and bond markets down sharply, in an eerie replay of the selloff that dominated the last two weeks of the first quarter.
The Dow industrial average lost 33.93 points to 3,707.97 on Tuesday, its lowest close since mid-May. And the yield on 30-year Treasury bonds rose to 7.49% from 7.46% on Monday, nearing the 1994 peak of 7.65% reached in mid-May.
This time, however, the carnage is a global event. European stock markets, which held up reasonably well even as the Dow slumped 300 points in late March, have led this decline. And in recent days the selling has spread to Canada, Mexico and many Asian markets.
Everybody wants to blame the markets’ latest turmoil on the dollar, of course, and that’s tempting enough.
For one thing, a weak dollar raises the prospect of higher U.S. inflation because prices of imported goods can automatically rise as the buck slides.
Moreover, if the dollar’s decline worsens significantly, the Federal Reserve Board may be compelled to raise interest rates to try to defend the currency.
Wall Street had just begun to feel confident that the Fed would wait until late summer before considering whether the economy warranted tighter credit. Now all bets on a benign Fed are off, and that’s bad news for countries whose short-term rates are, in effect, tied to ours (like Hong Kong and Mexico).
But some pros say the weak dollar is just a symptom of the markets’ real problem: We’re in a nearly global bear market in stocks and bonds, which means sellers are in control. Despite periodic rallies--like the one U.S. stocks enjoyed in early June--the overriding trend in financial assets is down, the bears argue.
“I see this as a step-by-step, grinding kind of decline,” says Richard McCabe, technical market analyst at Merrill Lynch & Co. in New York.
Not surprisingly, there are still plenty of people who resist the bear scenario. The optimists either see the dollar stabilizing soon, or they make the point that the dollar’s latest slide is a blip compared to how much it fell between 1985 and 1993. (Remember, the dollar bought 250 Japanese yen in the mid-1980s. So what’s the big deal about a drop from 111 yen to 100 yen this year?)
More important than the buck’s status is the frightening surge in long-term bond yields worldwide this year, in part a winding-down of wild speculation in bonds during 1993, many Wall Streeters say. The optimists among them believe that yields already have jumped this year to levels that are ridiculously high relative to the global economy’s growth rate and to inflation.
In Germany, for example, the yield on the benchmark 10-year government bond closed at 7.32% on Tuesday, up from 5.89% in early February and its highest since December, 1992. Yet inflation in Germany is running at about a 3% annual rate, which means the “real” yield on the 10-year bond currently is more than four percentage points--quite a payoff historically.
“These rates are too high relative to any kind of inflation we see worldwide at the moment,” argues Thomas Robinson, Merrill Lynch’s international investment strategist.
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The bull scenario is that the U.S. economy slows in the second half, thanks to the Fed’s first-half credit-tightening moves; Europe and Japan recover at a modest pace and without higher inflation, allowing bond yields in those economies to resume their declines, and corporate profits continue to rise worldwide, underpinning stocks.
The problem with the bulls’ case so far this year is that something always seems to come along to botch it up. In winter, the problem was the unwinding of the crazed stock and bond speculation fueled by so-called hedge funds last year; in the spring, rising commodity prices fanned new worries about inflation; and now the dollar is sinking, unnerving investors who naturally respond badly to any unforeseen market shock.
“When currencies move quickly, it scares people,” says A.C. Moore, investment strategist at money manager SBCM/Argus in Santa Barbara.
The great danger now is that the markets’ latest woes will encourage more American investors to do what their European counterparts have already been doing in spades: Forget the bullish case and just stay invested in short-term securities for safety’s sake. Or run to gold and other hard assets that traditionally offer refuge.
That’s a recipe for a bear market. And there’s a good argument that some European stock markets are already deep in a bear phase, on the heels of bear-like declines in Asia earlier this year.
In Paris, for example, stocks are already down 16.6% from year’s end, as measured by that market’s blue chip index. If a bear market is generally described as a minimum 15% to 20% decline in prices, much of Europe is there or close.
In the United States, the blue chip Standard & Poor’s 500-stock index now is off just 3.2% from year’s end, though its decline nearly reached 10% from its February peak to its spring low.
James Stack, publisher of the InvesTech market newsletter in Whitefish, Mont., and an unabashed bear, concedes that the relatively small decline in U.S. stocks thus far makes it tough for most Wall Street pros to join the bear camp.
Ditto the public, he says. “There’s a lot of talk about bearishness, but when one looks at the new money still going into stock (mutual) funds, the public is not bearish,” Stack says.
But as the current selloff in stocks and bonds hits home, following so closely on the March selloff, Stack expects the mind-set to turn increasingly cautious. “Historically, big bear markets come after periods of market frothiness, high expectations (for stocks) and high valuations” in stock prices, he says. We had the latter in 1993, he says; to deny the huge potential for a bear market now is absurd, he contends.
Gold Returns
Gold has been the big winner over the past two months, as stock and bond markets have languished. Weekly closes, except latest; Comex gold futures: Tuesday: $394.30 Source: Bloomberg Business News
