Reacting to a Dollar With No Muscle

NYTimes January 3, 2005

The big rises in gold and oil seemed larger when measured in dollars than they did when calculated in euros or yen.

But the most important fact about currency markets in 2004 was that the dollar did not budge against the Chinese yuan, or against other Asian currencies that are effectively tied to the dollar. The big issue this year will be whether those ties are broken, and, if so, how markets and economies will react.

Barring a dollar crisis, the economy seems likely to keep growing, and that should support share prices in 2005. For numerologists, there is the Rule of Five, which holds that the market always goes up in years ending in 5. The Dow industrials have risen more than 20 percent in every such year since the index began in 1896, with the exception of 1965, when the rise was a still respectable 10.9 percent.

The Dow Jones industrial average was the laggard, rising only 3.15 percent. It was held back by four of its members, which lost more than 20 percent of their values. Two were drug stocks, Merck and Pfizer, whose painkillers were linked to heart problems. The others were Intel, which seemed to stumble while rivals prospered, and General Motors, which continues to lose market share and faces huge bills for health care costs for retirees.

Some of those gains are reduced or even eliminated if an investor's holdings are converted from dollars into measures of value. The 9 percent gain for the S.& P. 500 would be just 4.3 percent computed in Japanese yen, or 1.3 percent in euros. And measured in the amount of gold needed to buy a basket of stocks, the gain was only 3.4 percent.

Even so, American investors were less interested in European stocks in the past year than in Chinese ones - or at least in companies that could claim to benefit from the Chinese boom.

Short-term interest rates are higher now, but long-term rates are nearly the same. Now, points out Kerry Reilly of Bridgewater Associates, traders are expecting long-term rates to rise in 2005, but not nearly so much as they had wrongly forecast for 2004.

A few years ago, foreigners were happy to buy American stocks, but that demand has almost vanished. In 2000, foreigners were net buyers of $458 billion of American securities, with 38 percent of that amount going into stocks. In the first 10 months of 2004, they put $746 billion into American securities, but less than one-half of 1 percent of that went into stocks.

Contrarians could argue that is a positive indicator: foreign investors rarely show good market timing in most parts of the world, presumably for want of local knowledge. So foreigners' lack of interest in American stocks could be a sign that the stock market is not near a peak.