Dollar bulls got an early holiday gift with the surge in the value of the U.S. greenback. They can tender their gratitude to signs of a rebound in the U.S. economy and even to Congress, whose last-minute deal to extend tax cuts helped out a bit.
Perhaps the biggest vote of thanks is owed to the European Union, however. Without the fiscal troubles of Greece and Ireland weakening the group's common currency and even calling into question its very survival, the euro may well have offered a more tempting alternative to traders, speculators and investors wary of the impact of the Federal Reserve's $600 billion quantitative easing plan.
SHIFT OF POWER
Few analysts are unabashedly bullish. "This is the toughest call to make," says Wai Lee, chief investment officer and director of research for the quantitative investment group at Neuberger Berman. The greenback, he says with a grimace, "is bouncing back and forth. We are taking a very, very cautious stance." That wariness is something that financial advisors may want to heed.
To be sure, advisors don't rely on a few months' worth of trading data, particularly in a volatile currency market. In addition, their clients are likely to have all but a fraction of their assets invested in dollar-denominated assets. Yet even those who have no non-dollar liabilities-no plans to retire outside the United States, no heirs living outside the country and no holiday home in Ireland-can't afford to ignore the dollar's fortunes.
The United States doesn't have to undergo a fiscal and currency crisis such as those that devastated Greece and Ireland in the last year in order for a shift in the value of the dollar to jolt investors' holdings, experts agree. As John Derrick, director of research for U.S. Global Investors, a mutual fund management firm, points out, "If the dollar falls-rapidly or slowly, short term or long term-that is going to cause the number of dollars I need to spend to get any imported consumer good to rise."
The near-term concern is Federal Reserve Chairman Ben Bernanke's second round of quantitative easing, also known as QE2. "The only way QE2 will work in the United States is by pushing down the value of the dollar," says Richard Cookson, chief investment officer of Citi Private Bank in New York. But long after the shoving and pushing in the currency markets around the size and timing of the Fed's policy have passed into history, concern about the dollar remains.
Tony Roth, New York-based head of investment strategy and wealth planning for UBS Wealth Management, points to the decline in the percentage of global GDP generated by the United States economy. Sitting at 20% today, UBS strategists expect that number to decline to a mere 10% within the next dozen years.
"We are at or approaching a historic inflection point, where the balance of power shifts decisively from the United States and the developed world-I'd call it almost the 'overdeveloped' world-to emerging nations," Roth argues. As those nations, such as Brazil, China and India, generate a greater share of global GDP and develop domestic markets as well as exporting their products, a similar shift in the balance of power will follow.
The beneficiaries of the shift, says S. Mackintosh Pulsifer, chief investment officer of Fiduciary Trust Co., will "deserve a spot at the currency table, and in time they will take it." Within 25 years, Pulsifer predicts, major commodities like crude oil and copper-today traded in dollars around the world and thus helping to ensure that the greenback remains the global currency of choice-will be purchased and sold in multiple currencies. "That will mean less use of dollars and less demand for dollars," adds Pulsifer, who helps some of the country's most affluent families manage multigenerational pools of wealth.
GOLD AND COMMODITIES
The combination of headlines about the dollar's plunge in value during the summer of 2010 and the potential impact of QE2 with these longer-term trends is attracting the attention of many financial planners. Even though few of them expect to witness the kind of cataclysmic event that could wreak havoc on dollar-denominated assets, they are nonetheless thinking ahead to a world in which the dollar is no longer all powerful.
"From an investment standpoint, you simply can't afford to be a saver any more," says William Larkin, portfolio manager at Cabot Money Management, a Salem, Mass.-based firm that oversees some $500 million in assets for high-net-worth clients. Instead of savings accounts, he is steering his clients into some form of gold-related investment.
"This is a bet on the belief that the United States doesn't have the ability or willingness to protect the dollar long term," he acknowledges, adding that all of his clients now have at least 5% in gold, with some holding an exposure of as much as 10%. (More than that would be too high, he says.)
Larkin isn't recommending that those clients stock up on bullion and stash it in lockboxes under their beds; he prefers a gold-oriented fund, such as the SPDR Gold exchange-traded fund (GLD). Using GLD, he says, gives investors not only a hedge against the dollar, but also a way to profit as more investors opt in favor of gold rather than holding on to any national currency.
The portfolio manager argues that uncertainty about the health of government balance sheets is one of the reasons behind gold's gains over the last decade and the record highs set by the precious metal in 2010. "If the dollar is facing a headwind, gold is benefiting from a tailwind as investors increase their allocations," he says.
Even advisors who aren't convinced that the dollar is in for a bumpy ride in the short run admit that they are keeping a close eye on commodities, looking for a price point at which they are comfortable boosting their clients' allocations. "If the dollar falls, then commodities benefit," says one advisor, who asked not to be identified. "If the dollar rises, commodities can still do well based on global supply and demand factors. It's a dollar play, but with a twist."
Another classic play on the dollar is investing in U.S.-based multinational companies like Coca-Cola, Nike and Wal-Mart, just to name a few. All of these companies earn revenues from sales overseas; a growing proportion not only manufacture overseas and sell abroad but have retail operations in high-growth regions of China and India. (Migrant workers living in dormitories on the outskirts of Shenzhen, China, routinely drop by their local Wal-Mart to snap up something for dinner, for instance.)
Bob Andres, chief investment officer of Merion Wealth Partners in Berwyn, Pa., spends a portion of his time studying the charts of these companies and comparing them to that of the dollar, seeking out those that increase in value in periods of dollar weakness. He also digs into the financial statements of companies whose reliance on global markets is growing. "You need to be careful that the dollar benefit isn't already priced into the stock," he warns.
A multinational that sells goods into the U.S. market can pass on costs to customers if the dollar does take a dive. "So you want to be aware of how much pricing power a company or industry has," explains Larkin, pointing to Intel as one example of a company that can pass on higher costs.
A number of other options for dollar hedging have arisen as markets have become more global and more sophisticated. For instance, Pulsifer reports that his firm's clients often end up investing in stocks of non-U.S. companies.
The rationale is the same whether the decision is to buy Wal-Mart or a non-U.S. company: "You want to own a company that is diversifying its operations and has the flexibility to source its raw materials in one currency and then sell in another." In other words, the advisor can trust the CFO or the treasurer of the company to manage the currency fluctuations in the way that most benefits the company's costs and earnings.
Today, that may even include taking advantage of non-U.S. capital markets. Take McDonald's; in August 2010, it raised approximately $30 million of three-year notes to finance the expansion of its Chinese operations. The surprise announcement? The debt was denominated in yuan, the first deal of its kind by a nonfinancial enterprise.
"They are making the decisions about what currency to invest in so that you, as the investor, don't have to," says Bill Stone, chief investment strategist at PNC Wealth Management in Pittsburgh. "About 40% of the revenue reported by the companies in the S&P 500 comes internationally. I'm pretty confident that most of those businesses have more insight into the dollar's relative strength than I or any other financial advisor is likely to have."
Non-dollar debt products, ranging from government bonds issued in local emerging-market currencies to commercial paper issued in Korean won, are increasingly accessible. There are still a limited number of mutual funds in this arena, but Larkin likes the Pimco Developing Local Markets Fund.
"They buy time deposits, government treasury securities and so on, held in local currencies," Larkin explains. "They are short-term securities, so there is no worry about the possibility of rising interest rates hurting their value. Indeed, if interest rates rise due to inflation in some of these regions, then when the fund rolls over into new securities, there is a chance to capture more yield as well as currency appreciation."
Most advisors remain wary of the currency market-but it is slowly becoming more accessible. All but the most daring may still balk at the idea of trying to outwit traders in the fastest-moving, largest and most volatile asset class of all. But these days, financial planners don't need to transform themselves into Forex whiz kids in order to take and manage a position on the dollar.
Rydex and PowerShares funds offer investors 200% of the inverse performance of the U.S. dollar, for instance. And if that kind of bet is too rigid, most large financial institutions can structure a note whose value is tied to that of a basket of diverse currencies and even offer some protection, Roth says. "Unless you know what you're doing, the currency markets can be tricky, but structured notes are a great alternative, and with a minimum investment of only $10,000, can be put together with all kinds of creative terms."
The one strategy that isn't advisable is just standing still and expecting the world to remain as it has been for decades into the foreseeable future. Clients turn to their financial advisors not only to manage their portfolios in response to what we know is happening today-a European fiscal crisis and a slow U.S. economic recovery, for instance-but also in anticipation of what may lie ahead, whether that is higher tax rates, rising inflation, interest rates that are lower still or even the end of U.S. economic dominance.
"Every decision we make for our clients involves a risk tradeoff, so it's only rational to consider what those risks are or could be down the road," Stone says. Perhaps the dethronement of the dollar is decades away; perhaps by springtime we will all be talking about the greenback hitting lows against its Canadian counterpart or even the euro.
"My clients may not understand at first what a weakening currency means, but my job as their advisor is to look ahead to anticipate the problems and propose solutions that will, incrementally, reduce their risks," he adds. "That's what I get paid for."
Suzanne McGee is a New York-based freelance writer and the author of Chasing Goldman Sachs.