Good news for stocks is good for the $

By Paul R. La Monica, editor at large


NEW YORK (CNNMoney.com) -- The dollar has gotten stronger this year. Is that because the U.S. economy appears to be improving -- or in spite of it?

For most of last year, it was pretty easy to guess where the dollar was going. When stocks were up, the dollar was down. And vice versa.

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Although stocks have had a wild ride, the market's up so far this year -- and so is the dollar (DXY) against a basket of currencies. Last year, the dollar and stocks rarely moved in the same direction.

That may seem odd, but here's the rationale: The dollar was benefiting from a so-called flight to quality. Even though the U.S. economy was in bad shape, the dollar was still viewed as a relatively stable investment compared to stocks, commodities and other currencies.

So good economic and earnings news was considered bad for the greenback because any evidence that the recession was over made investors willing to flock back to riskier assets such as stocks and dump safe havens like the dollar.

That's no longer the case. The dollar has gained nearly 3% this year against a basket of global currencies (including the euro, pound and yen) while the S&P 500 is also up 3%.

Why is this happening? Some think that it's simply a byproduct of the economy slowly getting back on track. The panic is gone and even the nagging sense that the worst may not really be over is starting to dissipate. The market's so-called fear gauge, the VIX, is currently near its 52-week low.

As the markets return to normal, there are fewer reasons to sell the dollar on good news. When you really think about it, it makes more sense for the dollar and stocks to trade in tandem.

"I never bought the story that a stronger dollar was bad for U.S. stocks. A stronger, more stable dollar is consistent with an economic recovery," said Stuart Hoffman, chief economist for PNC in Pittsburgh.

Sure, a weaker dollar does help the sales and profits of large multinational firms, your Cokes, P&Gs and Ciscos of the world. Revenue from markets outside of the U.S. wind up getting a lift when translated back into dollars when the dollar isn't as strong.

But that's purely an exchange-rate phenomenon. Andrew Busch, global currency and public policy strategist at BMO Capital Markets in Chicago, said that under usual circumstances, investors are far more likely to associate a stronger currency with a healthier economy.

"Stocks are percolating and doing quite well. The market looks rather buoyant since the U.S. economy seems to be growing," Busch said. "Having your stock market do well is always helpful for your currency since it can draw in more foreign investors. That can be self-fulfilling."

So this could just be another indication that the markets are returning to normal. The U.S. doesn't really benefit that much from a weak dollar. And last year's bizarro world trade -- selling the dollar anytime there was good economic news about the U.S. -- was just another example of investor fear and confusion.

Dollar getting stronger -- but still not strong

Still, it's not as if the dollar doesn't face any risks. Busch and Hoffman both pointed out that while the dollar is strengthening, it still isn't necessarily strong. Much of the dollar's gains this year have come at the expense of Europe and Britain.

"It's more euro weakness than dollar strength," Hoffman said.

The euro and pound have taken a hit due to concerns about the fiscal nightmare in Greece and fears that the economies of Portugal, Italy, Ireland and Spain (the rest of Europe's so-called PIIGS) could deteriorate further.

Busch said the dollar is no longer considered an "ugly currency" when compared to the euro and pound. But he noted that the dollar actually hasn't gained ground against the currencies of other countries, particularly Japan and commodity-rich nations like Canada, Australia, Brazil and Russia.

That may be a reflection that the U.S. economy is not really leading the global recovery -- it's just not lagging it as much as Europe.

There are also some concerns that the Federal Reserve may keep interest rates near zero for a lot longer, which could put pressure on the dollar.

Lower interest rates often dissuade investors from betting on bonds and dollar-denominated assets because there are higher rates of return elsewhere. Some also worry that "cheap money" could contribute to another bubble in housing, commodities or other assets.

But Keith Springer, president of Capital Financial Advisory Services, a Sacramento, Calif.-based investment advisory firm, doesn't buy such talk.

He said zero-percent interest rates don't have to lead to inflation and a weaker dollar. He thinks the Fed's priority right now should be to ensure that the economic growth of the last two quarters is sustainable and not a blip.

"Low interest rates for an extended period of time should spur growth, and that can still be attractive for the dollar. Continued economic expansion will drive the market higher," he said.

Reader comment of the week: There were several interesting comments about Wednesday's column on the recent spike in shares of the financial sector's Not Fab Four: Citigroup, AIG, Fannie Mae and Freddie Mac. I argued that all four remain deeply troubled. Paul Smith agreed.

"The Beatles they ain't!" he wrote. "All four will be in survival mode for years, not months & their share prices should reflect that. That's not going to stop money being shifted in & out of those stocks until fair value will eventually be found. My view of them is similar to ships afloat in the ocean. All hands on deck fully equipped but missing one critical component - their rudders."

-- The opinions expressed in this commentary are solely those of Paul R. La Monica.  To top of page

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