The New York Times January 3, 2005 Reacting to a Dollar With No Muscle By FLOYD NORRIS
THIS is going to be the year the world learns to live with a cheaper dollar. How well it does that may have a profound effect on prospects for continued world growth. That, at least, is the predominant opinion as 2005 begins.
The dollar's travails dominated the market news in the year just ended and were all the more important because they influenced perceptions of other events. The big rises in gold and oil seemed larger when measured in dollars than they did when calculated in euros or yen.
But the most important fact about currency markets in 2004 was that the dollar did not budge against the Chinese yuan, or against other Asian currencies that are effectively tied to the dollar. The big issue this year will be whether those ties are broken, and, if so, how markets and economies will react.
The dollar's weakness stemmed from the continued worsening of the huge trade deficits the United States was running at a time when foreigners were less than enchanted by investment opportunities in America. Still, foreigners continued to buy American bonds, and their purchases helped hold down interest rates and support share prices.
The American stock market, which had begun a powerful recovery in October 2002, saw the momentum fade away in the spring of 2004. But it returned at the end of the year, carrying the major averages to new post-2000 highs.
By year's end, the Standard & Poor's 500-stock index was up 8.99 percent for 2004, and the Nasdaq composite had gained 8.59 percent.
The Dow Jones industrial average was the laggard, rising only 3.15 percent. It was held back by four of its members, which lost more than
20 percent of their values. Two were drug stocks, Merck and Pfizer, whose painkillers were linked to heart problems. The others were Intel, which seemed to stumble while rivals prospered, and General Motors, which continues to lose market share and faces huge bills for health care costs for retirees.Most American stocks are now well above their levels of March 2000, when the records were being set. That the major indexes are well below those highs is a testament to just how far the stock darlings - largely in technology and telecommunications - of that bull market fell in the following years.
Barring a dollar crisis, the economy seems likely to keep growing, and that should support share prices in 2005. For numerologists, there is the Rule of Five, which holds that the market always goes up in years ending in 5. The Dow industrials have risen more than 20 percent in every such year since the index began in 1896, with the exception of
1965, when the rise was a still respectable 10.9 percent.Most indexes are well below the peaks they reached in 2000, but many investors are nonetheless sitting pretty. Most stocks in the S.& P. 500 are higher than they were when the index peaked on March 24, 2000. So are most stocks in the broader Russell 1000 index - the 1,000 most valuable stocks in the country - and in the Russell 2000 index - the next 2,000 stocks in terms of capitalization.
Standard & Poor's computes its S.& P. 500 on the basis of market capitalization, so that Microsoft and General Electric, neither of which is close to returning to its 2000 high, are the most important stocks. But if the index were computed instead on an equal-weighted basis - that is as if an investor put an equal amount of money into each of the 500 stocks -a very different picture would emerge.
By that measure, the index set a record in the final week of 2003, and was onward and up this year, rising 15.2 percent, significantly better than the official index's 9 percent gain.
Some of those gains are reduced or even eliminated if an investor's holdings are converted from dollars into measures of value. The 9 percent gain for the S.& P. 500 would be just 4.3 percent computed in Japanese yen, or 1.3 percent in euros. And measured in the amount of gold needed to buy a basket of stocks, the gain was only 3.4 percent.
The currency movements also mean that for American investors overseas markets generally did better than American ones. While leading European markets were up less than 10 percent in euro terms, because of the euro's appreciation they showed double-digit gains when measured in dollars.
Even so, American investors were less interested in European stocks in the past year than in Chinese ones - or at least in companies that could claim to benefit from the Chinese boom. Those chasing that boom in 2005 may be risking getting in at the top, but there is little indication that the urge to buy Chinese will stop.
The arguments for the dollar to fall further in 2005 seem persuasive to most analysts. There are few signs that the American government is getting its budget or trade deficits under control, and foreigners' appetite for American assets is not limitless. But only one year ago there was a similar market consensus - about interest rates - that proved to be wrong.
It was widely thought that 2004 was to be a year of rising interest rates. With the Federal Reserve poised to raise short-term interest rates from their extraordinarily low levels, it seemed inevitable that bond yields, which had begun rising in late 2003, would continue to shoot up in both the United States and Europe. That would finally squeeze the housing market and perhaps cause a slowdown in consumption spending.
The argument was convincing, but wrong. Short-term interest rates are higher now, but long-term rates are nearly the same. Now, points out Kerry Reilly of Bridgewater Associates, traders are expecting long-term rates to rise in 2005, but not nearly so much as they had wrongly forecast for 2004.
The housing market lives on, with some measures showing American house prices rising at a record rate, as are American spending patterns. That is one reason the American trade deficit has risen to record levels, and that in turn is a reason for the widespread expectation that the dollar must continue to fall.
Longer term, it is hard to see how the United States can withstand a current account deficit of more than 5 percent of gross domestic product. But, in fact, the trend can continue as long as foreigners are willing to take dollars for their cars, toys and clothing, and not insist on exchanging the dollar for other currencies. And that means they must find acceptable dollar-denominated assets in which to invest their dollars.
A few years ago, foreigners were happy to buy American stocks, but that demand has almost vanished. In 2000, foreigners were net buyers of $458 billion of American securities, with 38 percent of that amount going into stocks. In the first 10 months of 2004, they put $746 billion into American securities, but less than one-half of 1 percent of that went into stocks.
Contrarians could argue that is a positive indicator: foreign investors rarely show good market timing in most parts of the world, presumably for want of local knowledge. So foreigners' lack of interest in American stocks could be a sign that the stock market is not near a peak.
But it also means that they must do something else with their dollars, and that has led to huge purchases of Treasury and corporate bonds. At first glance American bonds might seem unattractive given low interest rates and the prospect of a decline in the dollar that could more than offset the interest income for foreign holders.
But so far foreigners' desire to keep the dollar from tumbling - and hurting their own economies - has led them to keep buying bonds. Asian central banks, particularly those in China and Japan, have been voracious buyers of Treasuries.
Those purchases have held interest rates down and encouraged American consumers, thus contributing to growth in the United States and abroad.
The situation has also contributed to a boom for companies that transport Asian goods to market. That can be seen in the Dow Jones transportation index, which rose 26.3 percent in 2004, even though competition and high fuel prices obliterated airline profits. Stocks showing gains of 45 percent or more included FedEx, the Burlington Northern and Norfolk Southern railroads and the J. B. Hunt and Yellow Roadway truckers.
To say that huge American trade deficits cannot go on forever is clearly accurate. To predict when they will start to shrink, and when Asian currencies will be allowed to increase in value, is much more difficult.
As this year begins, huge sums have been wagered in one form or another that the Chinese will finally let their currency appreciate, no longer fixing its rate to the dollar. The Chinese have warned that they will not act as long as the speculators are active, but that warning does not appear to have deterred many who have sought to evade currency controls and acquire yuan that they expect to rise in value. When Asian currencies do increase, the cost of imported goods will rise in America, producing inflation. But it is not clear what impact that will have on the stock market. A falling dollar would make American stocks look cheaper overseas, which could stimulate buying. But a fear that the dollar would keep falling could frighten foreigners away from American stocks.
The lack of overseas interest in American stocks in 2004 may have helped dampen the stock market's gains, but it did not send it down. Earnings were generally strong, and Standard & Poor's reports that dividend payouts and share repurchases by companies in the S.& P. 500 set records last year. It expects operating profits for companies in the index to rise 22.5 percent in 2004, for the best annual showing since 1988, and says profits are likely to keep growing, albeit at a slower pace, in 2005.
Investors showed their faith in corporate growth by displaying enthusiasm for new issues in 2004. Google, the most highly awaited offering of the year, ended the year up 127 percent from its offering price.
The best performing new issue in Europe was Imperial Energy, a British company that has oil assets in Siberia. It is losing money, but its shares have risen 766 percent since it went public in April. In the United States, the best-performing new issues were Chinese companies that rose more than 250 percent. One, Shanda Interactive, is an online game company. The other, 51job, is an employment service.
Even in markets in Europe and America, in other words, speculation is concentrated on Asia as 2005 begins.