Resurgent dollar slams Americans' foreign stock holdings

The once-struggling U.S. dollar suddenly is the strongman of the world’s major currencies. That’s great for Americans’ purchasing power -- but if you’ve noticed, it’s a heavy blow to the foreign stock holdings in your portfolio.

And because U.S. investors have pumped huge sums into foreign-stock mutual funds in recent years, this turnabout in the dollar may be much more painful for people’s nest eggs than previous rallies in the currency. You’ve probably got more at stake.

The dollar had mostly been falling in value since the beginning of 2002, but by spring of this year it was showing signs of bottoming. The DXY index -- which measures the dollar’s value against six other major currencies -- reached its low for the year on April 22 when it closed at 71.33. It didn't decline further despite all of the subsequent bad news about the U.S. economy and financial system.

The dollar then treaded water until late July, when it began to surge. The DXY index, at 76.67 today, has jumped 6.5% just since July 21.

The greenback has been very strong against the euro and the British pound. The euro slumped to $1.483 today, down from $1.592 on July 21 and the lowest since February.

There’s now a mad rush on Wall Street to get bullish on the dollar. Goldman Sachs & Co. joined the crowd today, declaring in a note to clients that "The Dollar Has Bottomed!" (Yes, with the exclamation point.)

As noted in this post last week, the dollar is rallying in part because global investors see prospects worsening for many economies outside the U.S., particularly in Europe. Also, the summer plunge in commodity prices is good for the buck because many investors had shoveled money into commodities in recent years as a hedge against a weak dollar. Now, some investors are selling commodities to move back into U.S. stocks and bonds, underpinning the dollar.

But the dollar’s new muscle comes with a price: If you own foreign assets, they’re being depreciated -- the flip side of what happened to those assets when the dollar was falling.

The accompanying chart shows net gains or losses on nine major world stock indexes since June 30, measured in local currencies and in dollars.

Germany’s DAX index, for example, is up 0.4% since June 30 in euros. But translated into dollars the DAX is down 5.6%. The Australian market is down 4.5% in Aussie dollars but has plunged 13.1% when translated into U.S. dollars.

If you own a foreign stock mutual fund, the dollar’s turnaround explains a lot about why the fund has (most likely) performed so poorly this summer.

That, alone, isn’t a reason to sell a foreign fund. But this is a good time to take a closer look at your overseas holdings, and whether you’re happy with the mix you have between foreign and domestic stocks.

Comments

[PNW Trojan]

When the dollar went from Superman to Wimpy, many mutual fund recorded extra earnings as foreign exchange then bought more dollars, in repatriation. Now, the situation is reversing and one can lose VERY RAPIDLY, if (!!!!!!!), or should the dollar continue to strengthen. Most retail investors bought the MEDIA's Kool-Aid, and over the past year or two, started to invest overseas - much more than a day late, and MUCH, MUCH more than a dollar short. Best advise? Buy when blood in the streets, sell during 'It's Different This Time' euphoria.

[Lou Thomas]

In my opinion, this is intervention, not inherent U.S. economic strength or Eurozone economic weakness.

First of all, look at the U.S. economic news - every day there are historic down side events. Where is the good news here upon which a dollar rally could be based? The question is what disaster will befall us next? Fannie insolvency? Freddie insolvency? Housing values? Consumer spending? More writedowns beyond subprime in Alt-A, credit card debt (up $15 billion in July), auto loans, student loans? Hundreds of new bank insolvencies, leading the FDIC to appeal to the government for a bailout (it had only 53 billion, and Indymac alone took about 23 billion up front, all of which but 4-8 billion will be recovered, but not for 6 years or so, so they could run out after a few more such failures). Stock values as consumers shut their wallets? Credit double crunch as the U.S. government pumps hundreds of billions into the deflating housing bubble by bailing out the GSEs and maybe the FDIC, and has to issue more treasuries at very high interest rates to fund those bailouts? Flight of foreign capital from GSE bonds and treasuries?

Then, look at the Eurozone news - the problems are small by comparison. Sure, there is a spreading recession, but it is starting in the U.S., and its worst effects by far will be here, for too many reasons to mention. To totally understate the case: the Eurozone economy is much better than that of the U.S. Is the Eurozone running an enormous trade deficit? Has the Eurozone cored out its industry through offshoring (not unrelated to the deficit issue)? Is the Eurozone running up enormous, unsustainable budget deficits? Is the Eurozone at war around the world far beyond its economic capacity? Is the Eurozone sitting on a housing credit bubble that threatens the entire economy?

Sure, there are a few problems in Spain with the housing market, but those bonds are covered bonds which are regulated to have much higher loan to value ratios and which are based upon loans that have not been lent out to paupers. Sure, there are European banks that got into the subprime party and now have big hangovers, but those are knock-on effects from the much larger U.S. disaster.

Under the circumstances, G7 central banks are probably terrified that there will be a disorderly decline of the dollar. In my opinion, this has caused them to invert reality through costly intervention to stop traders and the public from piling on.

There seems to be some evidence of direct U.S. intervention on behalf of the dollar. According to economist Axel Merck, "Given a sharp drop in euro holdings in the U.S. Treasury’s Exchange Stabilization Fund, it seems that the U.S. Treasury may have intervened in the currency markets, possibly out of fear that a more significant run on the dollar could have resulted while Congress was pondering about its GSE bailout. While taking out insurance against such a scenario may be understandable, we would argue that the recent surge in volatility may well be the side effect of such intervention. Without having proof, we would not be surprised if other countries, notably Asian governments, also interfered in the markets, although with very different motivations."

True, this guy is invested in non-dollar currencies, but ad hominems aside, it is a significant observation. As for Asia, it may be that China in particular has more room to support the dollar again now that commodities are coming down, and with them, Chinese inflationary pressures. But the currencies that fell the most vs. the dollar in the past two weeks are the Euro and the Swiss Franc, followed by the pound and a few others. The yuan remained relatively stable. So, I doubt that Asian intervention was a major part of the present dollar uptick.

As evidence that there is direct intervention foreign central bank intervention, I found a very interesting article here (go to this page and then click on "Mystery Solved"):

goldmoney.com/en/commentary.php

"When central banks intervene in the currency markets, they exchange their currency for dollars. Central banks then use the dollars they acquire to buy US government debt instruments so that they can earn interest on their money. The debt instruments central banks acquire are held in custody for them at the Federal Reserve, which reports this amount weekly.

"On July 16, 2008 (the closest date of the weekly reports to the July 15th low in the Dollar Index), the Federal Reserve reported holding $2,349 billion of US government paper in custody for central banks. In its report released today, this amount had grown over the past three weeks to $2,401 billion, a 38.4% annual rate of growth. To put this phenomenally high growth rate into perspective, for the twelve months ending this past July 16th, assets in the Federal Reserve's custody account grew by 17.3%, which is less than one-half the growth rate experienced over the past three weeks."

OK, this guy is invested in gold, but once again foregoing ad hominems, that is $650 billion in just three weeks. To give an idea of how much money that is, I think it is about 4.4 percent of the annual GDP for the entire Eurozone. One would have to think that intervention at those levels is not sustainable. Rather, it is probably an attempt to batten down the hatches by wringing out speculative bets vs. the dollar in preparation for the inevitable continued eruption of very, very bad economic news from the U.S. The goal would probably be to prevent a disorderly decline of the U.S. currency.

Of course, nobody can really know what is going on, but it would have been nice for this blog article to at least mention the possibility of direct intervention, or else to say why that is *not* a likely factor.

[Lou Thomas]

CORRECTION:
Sorry, I made an egregious error: The increase in U.S. paper held in custody by the Fed for central banks increased "only" $52 billion in three weeks, not the whopping $650 billion that I had somehow mis-subtracted. So that is just 0.35 percent of Eurozone annual GDP. Still, on an annualized basis, that amount would be equal to 6.1 percent of Eurozone GDP, a significant number.

So, I would modify my conclusions, then, to say that the such an intervention is not as clearly unsustainable as I had thought. But it still shows double the average accumulation, which is evidence that foreign central banks are indeed intervening.