Falling Dollar Adds to Investor Woes

WSJ, November 11
GREGORY ZUCKERMAN and CRAIG KARMIN

The dollar tumbled last week and took the stock market with it.

The weak greenback was just one more thing for stock investors to fret about. The combined weight of their concerns has knocked the Dow Jones Industrial Average down 7.9% from its record close just over a month ago.

As the housing meltdown drags on, losses on mortgage-related securities continue to mushroom, including news last week of write-downs by American International Group, Morgan Stanley and Wachovia. Disappointing October retail sales stoked concerns that consumer spending is being impacted by the housing downturn as well as by near-record oil prices. Federal Reserve Chairman Ben Bernanke Thursday said Fed policy makers see economic growth slowing "noticeably" in the current quarter.

Meanwhile, the tumbling dollar could make some overseas investors reluctant to hold U.S. securities and could make it tougher for the Fed to cut interest rates further.

Painful Week

Buffeted by one concern after another, the Dow industrials last week declined 4.1%, trimming their year-to-date advance to 4.7%. The technology-heavy Nasdaq Composite Index, recently the better performer, saw a steeper 6.5% drop. So far in 2007, the Nasdaq is still up 8.8%.

Stocks will likely continue to be bumpy. And while shares have often done well in the final months of the year, investors shouldn't get their hopes up this year. "Given the uncertainty surrounding the banks, the market probably needs either a big drop in oil prices or an additional Fed easing to see a repeat of the fourth-quarter rally we've seen over the last four years," says Jason Trennert, chief investment strategist and managing partner at Strategas Research Partners, a research firm in New York.

A Slowing Economy

Corporate profits reported so far for the third quarter are down about 2.4% from a year ago, according to Thomson Financial. While most economists don't predict a recession, or downturn in economic activity, a marked slowdown seems to be emerging as the most likely scenario.

"The economy faces a protracted period of subpar growth rather than a recession," says Martin Barnes, managing editor of The Bank Credit Analyst, a Montreal-based publication. "The biggest risk to our view is that the contagion from housing to consumer spending [proves to be] greater than we expected."

Mr. Bernanke said last week that the Fed expects the economy to remain "sluggish during the first part of next year" and then strengthen.

One concern is that growing troubles for financial companies could spur them to curb their lending, putting a crimp on the economy. Deep writedowns and losses at Citigroup, Merrill Lynch and other financial heavyweights in recent weeks underscored how these companies had too much exposure to the subprime mortgage market. Now, investors are concerned about the potential for more markdowns ahead.

Dollar Woes

Last week, the U.S. currency suffered one of its worst weeks in years, plummeting to a record low versus the euro and touching its weakest level against the Canadian dollar in more than five decades. Lower U.S. interest rates have contributed to making the dollar less attractive to overseas investors.

Despite the powerful sell-off -- one that some analysts are starting to say looks overdone -- few traders or investors expect much of a relief rally for the dollar anytime soon. That's because the currency has become so unloved.

"Market psychology regarding the dollar is deteriorating rapidly," Morgan Stanley currency analyst Stephen Jen wrote in a recent report.

A steady decline in the dollar isn't necessarily a bad thing for the U.S. economy. A weaker currency makes American products more competitive abroad, and overseas profits have been rising for many large U.S. firms.

But if the dollar falls too far or too quickly, it can cause problems: U.S. assets look less attractive to foreign investors, and foreign goods become more expensive, which could lead to inflation.

The dollar weakness could also put the Fed in a bind. The Fed may be inclined to cut rates further to help revive a slowing economy and ease credit concerns. But lower rates would only make the dollar less attractive to foreigners and cause it to fall more.

Analysts see further dollar declines through year end.

Looking at Stocks

At this juncture, some market watchers say many areas of the U.S. stock market look attractive -- but only as long as the U.S. steers clear of recession. The Standard & Poor's 500-stock index now trades at about 16 times its expected earnings for this year, a reasonable price. And the yield on the key 10-year Treasury note has slid to 4.2% from over 5% this summer, making stocks more attractive by comparison.

Analysts say it's too early to buy beaten-down financial shares, partly because it is not yet clear how much the assets they're holding are worth. Instead, it's best to focus on stocks that continue to generate strong earnings and are in sectors that are less impacted by housing woes.

For instance, some analysts say Nike (NKE) should be helped by global excitement about the 2008 Olympics, and they say the shoe and apparel company is doing a good job making inroads against competitors like Timberland and Under Armour. Nike is expected to grow profits 18% in the next year, and trades at a price/earnings multiple of about 18.

The company is growing profits at more than a 20% clip in Asia, which may be able to keep Nike's earnings flowing even as the U.S. continues to slow, some say.

Write to Gregory Zuckerman at gregory.zuckerman@wsj.com and Craig Karmin at craig.karmin@wsj.com