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Investing abroad: Will dollar stay friendly?

May 06, 2007|TOM PETRUNO

To protect the purchasing power of your money over the last five years, one of the best strategies was to send it abroad.

Foreign stock markets overall have risen faster than U.S. shares since 2002. And a big bonus for American investors in foreign securities has been the currency effect: As the dollar's value has sunk against many of its global rivals, returns earned abroad have been juiced significantly.

To appreciate just how friendly the dollar has been to U.S. investors with money overseas, consider the performance of a Bloomberg index of 500 European blue-chip stocks.

That index rose 90% from the end of 2002 through last week, compared with a 71% price gain for the U.S. Standard & Poor's 500 index.

But add in the effect of the euro's surge against the dollar in that period, and the rise in the European blue-chip index was 147% when translated into dollars -- twice the S&P 500 return.

To view it from another angle, the dollar's slide has eroded your purchasing power in the world, making that overseas vacation, and many imported goods, more expensive.

But if you owned assets abroad, the gain from the change in currency values helped make up for some of that loss of purchasing power.

Egged on by the greenback's latest slump, a long-popular view on Wall Street is back in focus: the idea that the dollar is in a sustained downturn. A "secular decline" is how Newport Beach-based bond fund giant Pacific Investment Management describes it.

According to this school of thought, a continuing deterioration of the dollar's value would be our national penance for borrowing and consuming too much, and saving too little, for decades.

It also would be a reflection of the rise of economic power in the developing world, and our relative decline: They get richer and we get poorer, and the currencies mirror that.

If the buck is destined to wither further, the message to investors would seem to be, keep loading up on non-dollar assets -- foreign-stock mutual funds, for example -- unless you want your purchasing power to melt away.

Gold also is at the top of the list when many investment pros look for alternatives to the dollar. It's no coincidence that, as the dollar has fallen, gold has shined. At $687.20 an ounce Friday, the metal has nearly doubled since the end of 2002.

But predicting a currency's long-term trend is a difficult game. Foreign-exchange rates are determined by a host of factors related to economic health: differences in countries' inflation and interest rates, trade balances and government budget surpluses or deficits.

Even then, currency moves sometimes make no sense. While Japan's economy crumbled in the early 1990s, the yen soared against the dollar.

One seemingly sure path to a dollar collapse would be for foreigners to stop pouring money into U.S. stocks, bonds and other assets, and therefore to stop funding the spending that has fueled our budget and trade deficits. That doomsday scenario has been discussed for decades. We're still waiting.

Jay Bryson, global economist at Wachovia Corp. in Charlotte, N.C., says the simple fact is that "the world's most sophisticated and transparent capital markets are in the U.S." Foreign investors can't ignore that when looking for a home for some of their money, he says.

And given the size of their dollar holdings, foreigners have no incentive to fan a panic-inducing downward spiral in the U.S. currency. That would just slam their own portfolios -- and ruin what is for many (think: China) a crucial market for their exports.

Another issue raised by dollar pessimists is the potential for the bankruptcy of the Social Security and Medicare systems if the economy can't keep up with the drain that aging baby boomers will place on the systems.

Yet the demographic outlook is hardly any rosier for Japan or Europe, the homes of the dollar's main currency rivals.

The spectacular currency-enhanced performance of foreign securities in recent years has left some money managers in a tough position, they say. Typically, they recommend that their clients have between 15% and 30% of their portfolios in non-dollar assets. But now, clients often want more, forgetting the risks, says Mark Petrie, a fund manager at Solana Beach-based wealth management firm Hokanson Associates.

"People are notorious for wanting what has just worked" in the recent past, he said.

Indeed, U.S. investors have been pumping far more cash into foreign stock mutual funds than U.S. funds for the last few years, a trend that continues. Foreign funds took in $6.6 billion in fresh cash in March, compared with a $1.6-billion inflow to domestic funds, according to the Investment Company Institute, the chief fund trade group.

If the dollar were to rally instead of slide further, U.S. investors could be in for disappointment. That's what happened in 2005, when the dollar jumped against the euro. European blue-chip shares rose 21% that year in euros, but the dollar's appreciation cut that gain to just 5% for U.S. investors.

Foreign investments' appeal should be judged on their fundamentals, not on currency hopes, Petrie says. Right now, he says, his firm believes that U.S. multinational stocks, which have lagged behind many foreign markets in this decade, are more attractive than a lot of the opportunities overseas, particularly in emerging markets.

The best thing about the hot streak in foreign markets since 2002 is that it has shown many U.S. investors the benefits of global diversification.

Just don't assume that you're going to get the same boost from currency shifts that you got in the last five years. The dollar may well be in a long-term decline -- or it may opt not to follow the script that's been written for it.

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