Strong International Exposure: Dampened By Strong Dollar?

You know, it is kind of funny if you look back to last year, almost anyone who was bullish on a stock would be able to cite strong international growth as a key driver going forward. Rightfully so, given the turmoil that was about to unravel within the United States credit and housing market, people needed to make sure their stocks would be able to weather a significant downturn in US corporate and consumer spending. Subscribing to the theory of international markets decoupling from US markets, seemed to be the hot thing to do with the dollar plunging even further, the stock market entering an official bear market, oil soaring to new highs everyday, and a housing market with no end in sight.

One year later, while the problems in America are far from over highlighted by the government bailout of Freddie Mac (FRE) and Fannie Mae (FNM), maybe the United States, at this point in time, is a better play going forward. It seems like maybe international markets are not decoupling from the US, but coupling in what seems like even greater evidence of the amount of globalization that has taken place over the past few years. But why all the optimism about the US economy all of a sudden?

International Economies

Don’t get me wrong, the United States is not some super country all of a sudden; it is still my belief that we are in a recession that will last into the 1st quarter of 2009, but in comparison to the rest of the world, the United States seems to be in much better shape. Take Germany for example. This country is a country that is extremely dependent on exports, as they are the largest exporter in the world. With what looks to be the beginning of a global slowdown, exports in July fell 1.7%, much worse than consensus expectations. Britain is starting to go through their first slowdown in 17 years and it looks like it could be extremely prolonged, with a housing crisis worse than the United States, unemployment more than double their target rate and retail sales coming in worse and worse every month. France has already experience 2 quarters of negative GDP. Let’s just say that throughout the whole Eurozone the outlook is extremely bleak looking forward.

So what about those emerging markets that had been performing so well? Even most emerging markets are struggling to keep up with the negative backlash from the US slowdown. Inflation is skyrocketing in places like China and India, as the meteoric growth the countries saw is looking like it could hit the brakes very soon, due to slowing exports with the global slowdown and problems with oil, one of the reasons for the recent run up in crude prices. The iShares MSCI emerging markets index (EEM) and Vanguard Emerging Markets ETF (VWO) have taken complete nosedives, going from their 52 week high to its low in a little more than 3 months. All of a sudden the growth in these areas no longer exists.

Let’s face it, we are in a global slowdown that started in the US. That being said, it seems like the US has weathered a greater amount of this storm, while it is just starting to hit the other countries. Corporate and consumer spending is likely to experience extremely negative trends going forward. So all those US equities that were heralded for having strong international exposure, will probably find themselves in a very tough sport going forward, with the lack of help from economies around the world. Not to mention the effect I’ll call “The Great Dollar Reversal.”

The Great Dollar Reversal

For the past 5 years, the dollar has clearly been in a bear market, as it had lost almost 30% of its value, as the Euro and Pound and other currencies took control of the foreign exchange market. The dollar’s recent demise during the Spring of 08 was caused by a failing US economy and sky rocketing commodity prices. But all of a sudden, the US Dollar Index has gone up over 10% in little over a month as the problems mentioned above in international economies have opened up an opportunity for the dollar to surge.

Look at the chart below and it is easy to see just how dramatic a change has occurred with the dollar. In fact, just today the US/EUR rate went below the critical $1.40 mark from over $1.56 a month ago. When the dollar makes moves, it historically maintains a certain trend for at least a few years (as evidenced by the recent 5 year drop), which makes me believe, as more economies abroad start to fail, the dollar will continue to prosper.

So all of a sudden these companies with international exposure, will now see profits decline when currency effects take place. Converting those sales from the Euro to the Dollar will no longer be something the shareholders should look forward to. So now the question becomes: what performs best during a dollar rally? According to Merrill Lynch, healthcare stocks perform the best during a dollar rally, with consumer staples not too far behind. That being said, considering that these are very defensive sectors, there is no reason a rational investor should shy away from these defensive plays in this extremely volatile market, as they could provide decent returns, in a market where achieving positive returns has been extremely hard, even for some of the worlds best portfolio managers. Even gold, the typical hedge against a falling dollar, has already started to suffer falling below $800/ounce. All signs are pointing to a surging dollar in the next few years, so for those who heralded the international exposure, it may be time to rethink that strategy and move towards firms with domestic exposure. As Bill Schreyer once said, “I’m Bullish on America.”

Disclosure: The author does not hold a position in any of the stocks mentioned

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