Marty's Market View Blog - Because Your Money Matters.

Is this seven month stock market rally the real deal? Does Dow 10,000 reflect improved corporate earnings, a rebounding economy, record low interest rates and trillions of sideline cash? Or, is it no more legitimate than the current homerun record?

The doubters tell us that the market’s recent gains result from nothing more than some misplaced exuberance (in the wake of the Fed injecting the financial sector with what amounted to a record dose of monetary steroids). They argue that corporate earnings have thus far come entirely from cost cutting, that the consumer’s over-leveraged, that the current administration is hell-bent on punishing corporate America, and if you’re naïve enough to believe a new bull market is under way, you probably believe a grown man can “naturally” gain thirty pounds of pure muscle and jump two hat sizes in a year (I know, he’s been working out really hard).

While the believers agree that corporate earnings to this point are indeed the result of heavy cost cutting, and that the Fed’s been very accommodative, they say “well duh – we’re in a recession stupid”. They argue that when the economy comes back (in spite of Washington) these leaner companies will continue to blow away earnings expectations, keeping this rally alive well into 2010. And granted, there is a $400 billion “stimulus” injection coming next year – but you should think of it as a healthy energizer, like a B12 shot, not a steroid.

So whom do you believe, the pessimists or the pollyannas? I’d say either, neither or both. It ultimately doesn’t matter because the money you and I have in the market is our long-term money, right? A couple weeks ago I tapped the archives and sent you an excerpt that listed 1.2 crises per year for the 24 years ending July 2008. What I didn’t share was that when I started my career back on August 1, 1984, the day after my 12th birthday (give or take), the Dow was at 1,135. Need I say more?

Well yes, I need say more. Why? Because what the market does today and tomorrow (now let’s be honest) has a direct impact on your mood. I can type till I’m blue in the fingers and you’re still going to feel good when your portfolio’s up and not so good when it’s down. Therefore, only because I care, I get to spend a little time (happily by the way) each week helping you keep things in their proper perspective.

And today’s hullabaloo that needs perspectifying is the declining U.S. Dollar. After rising briefly last fall, the good old greenback has been under intense pressure ever since. And according to more than a few “experts”, if the dollar doesn’t receive some serious attention soon, the U.S. will see the end of its economic dominance on the planet earth.

The funny thing is, while the dollar sports a rep worse than a batting champ with a dirty specimen, the U.S. stock market’s been getting more love than Tiger Woods. In fact there clearly exists a negative correlation between the two (at this moment) – on days when the dollar declines, stocks rally – on days when the dollar rallies, stocks decline.

So if a weak dollar is so bad, why are stocks doing so good?

To keep it brief, I’ll set the stage for my answer by bullet-pointing the pros and cons of a falling dollar…

Pros
• A weak dollar makes U.S. goods cheaper for foreign customers. I.e., it’s great for U.S. exporters and their stock prices. Something like 40% of the average S&P 500 company’s business (66% for the average tech company) comes from overseas. It’s therefore good news for our trade deficit as well.
• A weak dollar means foreigners flock to the U.S., since their foreign buck goes further when the dollar’s down. This bodes very well for our travel destinations (theme parks, national parks, etc.) as well as our hotel, restaurant and rental car businesses.
• A weak dollar means higher commodity prices – which under normal conditions is called inflation (usually a bad thing), but it’s called reflation (a good thing) when it immediately follows a period of deflation (like now). Got it?
• A weak dollar increases the at-home value of foreign securities. I.e., if one Euro was worth a buck twenty when you originally bought your Euro-focused mutual fund, and one Euro now fetches a buck fifty, you’ve just made a handsome profit without the fund’s holdings moving a dime.

Cons
• A weak dollar is inflation by definition (everything priced in dollars, like gold and oil, goes up). When the dollar weakens, the things we buy from foreigners (what don’t we buy from foreigners?) become more expensive.
• Since a weak dollar means higher prices for foreign goods, it spells trouble for foreign exporters who do their business in the U.S. (offsetting the aforementioned advantage of your “Euro-focused” mutual fund).
• Since a weak dollar means trouble for foreign exporters (as their revenues decline), if it goes too far or lasts too long, it can mean bad news for U.S. exporters (like chip makers for example) who supply those foreign exporters. Got it?
• Our government’s huge appetite for spending, and huge consequent deficits, requires that it/we borrow (big time) to stay afloat – we’ll sell our treasury debt to anyone from anywhere at any time. And when the dollar weakens, the value of our foreign lenders’ U.S. holdings diminishes. Some “experts” fear that if this continues, our over-seas benefactors will stop lending to us, which would force the dollar even lower and interest rates (and inflation) through the proverbial roof.

So now that we understand the pros and cons of a weak dollar, the question remains, is our currency’s current state a good or a bad thing overall? I’ll say, for the moment anyway, that the falling dollar clearly represents a glass-half-full scenario (just ask the stock market). And as much as the Federal Reserve and Uncle Sam would have us believe otherwise, their actions suggest that they believe a weak dollar is in our best interest (for now) as well.

In the long-run however, if we can’t overcome our addiction to government spending, and if our dollar continues to shrink faster than a bodybuilder’s testicles, we’ll have some real hell to pay. Trust me, while a shriveling dollar may be fine for now, we absolutely do not want to end up sounding like Minnie Mouse as we negotiate our position on the global stage of the future.

Have a great week,
Marty