By Michael Brush, MarketWatch
Here’s a basic rule of investing. When everyone is crowded into a trade, run the other way.
That’s what we have right now with the U.S. dollar /zigman2/quotes/210598269/delayed DXY -0.31% . A crowded trade. It is hard to find anyone who isn’t bullish on the dollar.
So it makes sense to bet the other way. You can do this by purchasing exchange traded funds that offer short dollar exposure, such as PowerShares DB US Dollar Bearish ETF /zigman2/quotes/203695033/composite UDN +0.33% , shares of companies that do well when the dollar weakens including Philip Morris International /zigman2/quotes/201611010/composite PM +0.65% and Merck & Co. /zigman2/quotes/209956077/composite MRK -0.39% ; and commodities including gold and oil /zigman2/quotes/209724088/delayed CLH25 0.00% , or many of the companies and countries that produce them.
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Plus, I’m suggesting additional stocks, ETFs, and one exchange traded note, as bets against the dollar.
But first, why will the dollar fall, when everyone thinks it will rise?
Economist and Wells Capital Management strategist James Paulsen, a consummate contrarian, offers three reasons:
1. European and Japanese monetary policy succeeds
The bullish case on the dollar holds that if the Fed starts hiking rates in 2015, as expected, while Europe and Japan are cutting rates or keeping rates low to promote growth, money will be drawn to the U.S. to get exposure to those higher interest rates. That would boost demand for the dollar, and its value.
But what if easy monetary policies in Europe and Japan actually work? The improved growth in those regions, which Paulsen expects, would attract investment money to those areas, bidding up their currencies against the dollar.
2. Investors begin to worry about inflation in the U.S.
With the U.S. nearing full employment and its economy growing at as fast a pace as we have seen during the recovery, inflation could finally pick up. Paulsen thinks an increase to 3% annually, from the current levels of around 1.5%, is possible. But even a more modest pickup in inflation could bring a big mood swing among investors, given that so many people still expect deflation. The dollar would be among the assets hit by increased worries about inflation.
“If the Fed begins raising interest rates, but only after most investors believe they are behind the curve, worsening inflation anxieties would reduce the value of the U.S. dollar,” Paulsen says. Investors often flee currencies whose values are being eroded by inflation.
3. The dollar is at the edge of its long-term trading range
For the past 10 years, the dollar has been trapped in a broad range against the currencies of other developed regions, like Japan and Europe. The dollar-euro /zigman2/quotes/210561242/realtime/sampled EURUSD +0.0085% rate, for example, has stayed between $1.20 per euro at the dollar’s strongest, and about $1.40 to $1.50 per euro at its weakest.
That’s not by chance, Paulsen says. Because the U.S. and the rest of the developed world face a similar challenge — the aging of the population that puts a cap on potential growth — no region wants other regions to get a leg up via currency devaluation, which can boost growth by making domestic goods look cheaper abroad.
Right now, the dollar is at its trading range limit against the euro (see chart below). The dollar is bouncing along the bottom of the chart, the zone that represents the greatest dollar strength (lowest amount of dollars it takes to buy a euro).