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 (IFUS:DXY) . 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 (PSE:UDN) , shares of companies that do well when the dollar weakens including Philip Morris International (NYS:PM) and Merck & Co. (NYS:MRK) ; and commodities including gold and oil (NYM:CLH25) , 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 (XTUP:EURUSD) 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).
Not even the worst fears of a eurozone breakup in 2010 and 2012 could weaken the euro so much that the dollar popped out of its trading range to strengthen even more, or move closer to parity with the euro. If the threat of the euro breakup wouldn’t do it, nothing in the current environment will. The dollar is maxed out here, and has nowhere to go but down.
Dollar/euro spot rate, 2004-2014
James Paulsen, Wells Capital Management
Source: Wells Capital Management
If the dollar does fall in 2015, what benefits?
1) U.S. companies that get a substantial amount of revenue abroad
2) Commodities including gold and oil, and the countries and companies that produce them.
U.S. companies with sizeable international business
As the dollar weakens, revenue earned in foreign currencies translates into more dollars, which boosts earnings.
Large consumer staples companies often fit the bill here, says Peter Tuz, president of Chase Investment Counsel and co-portfolio manager of the Chase Growth Fund (NAS:CHASX) .
The most extreme example is Philip Morris, which owns the international rights to popular cigarette brands such as Marlboro, Merit, Parliament and Virginia Slims. “Here is a U.S. company doing virtually all of its business overseas,” Tuz says.
The company’s earnings estimates have been slashed repeatedly because of the strong dollar, and the stock has suffered as a result. This would reverse if the dollar weakens. Philip Morris has some issues, to be sure. Many governments abroad are going the way of the U.S. and taking steps to curtail smoking. “Yet they are gaining share in most of the countries they are in, as smokers trade up from the local brand to Philip Morris brands,” says Tuz. The company pays a 4.8% dividend yield.
Other U.S.-based global consumer products companies whose reasonably good health is masked because the strong dollar lops off a few percentage points of growth in the translation of foreign revenue into dollars include: Coca-Cola (NYS:KO) PepsiCo (NAS:PEP) and Procter & Gamble (NYS:PG) . “The stronger dollar just makes companies with decent growth look sluggish,” Tuz says. A weaker dollar would reverse this, and generate more investor interest in these companies.
The big U.S.-based pharmaceutical companies generate a lot of income abroad, so they fit the bill, too. Merck, for example, derives more than half of its sales abroad, points out Patrick Kaser of Brandywine Global Investment Management.
A weakening dollar would also tilt the balance towards U.S. companies in a couple of long-standing international rivalries, since it would make their products look more attractive against those of direct foreign competitors. Kaser cites Boeing (NYS:BA) over Airbus Group (OTC:EADSF) . And General Motors (NYS:GM) would edge out Toyota Motor (NYS:TM) .
Commodities, gold and oil
Commodities and gold are priced in dollars worldwide. So a weaker dollar can increase demand for them and boost their prices. The dollar and oil also have a long-standing inverse relationship. If the dollar is going down, oil is most likely going up.
So if a weaker dollar is on the way, it makes sense to up exposure to all of these commodities and the companies and countries that make them. Consider long exposure to exchange traded funds such as SPDR Gold Trust (PSE:GLD) Market Vectors Gold Miners ETF (PSE:GDX) PowerShares DB Commodity Index Tracking ETF (PSE:DBC) , and United States Oil Fund (PSE:USO) . Also consider Canada and emerging markets where a lot of commodities are produced, via iShares MSCI Canada ETF (PSE:EWC) and iShares MSCI Emerging Markets ETF (PSE:EEM) .
For specific companies in gold, Frank Holmes at U.S. Global Investors likes royalty companies, or those that collect a percentage of the take for letting others produce their properties. Three favorites of his are Royal Gold (NAS:RGLD) , Silver Wheaton and Franco-Nevada (NYS:FNV) .
You can also short the dollar by purchasing PowerShares DB US Dollar Bearish ETF, and the highly leveraged PowerShares DB 3x Short US Dollar Index Futures ETN .
At the time of publication, Michael Brush held shares of PM and USO. Brush has suggested PM, KO, PG and USO in his stock newsletter Brush Up on Stocks.