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How the Weak Dollar Sparked the Fireworks for Dow 10,000

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By Gary Gordon
16 October 2009 @ 11:15 pm ET

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From the bull market top to the bear's March 09 low, both the Dow 30 Industrials and the NASDAQ 100 had surrendered more than 50% in value; in ETF parlance, both the Dow Diamonds Trust (DIA) and the Powershares QQQQ gave up nearly identical amounts in unrealized losses.

However, the bear-to-date "comeback" strongly favors the Nasdaq 100 over the Dow 30. The Powershares QQQQ is only 20% off of its bull market peak whereas the Dow is 30% off its pinnacle.

Why is this significant? For one thing, the world often regards the Dow as the less risky stock index. Consider the bear market losses for 2000-2002 where the Dow posted -33%, the S&P 500 logged -50% and the Nasdaq 100 came in with a life-altering -80%. Clearly, the Dow and Nasdaq 100 sharing a similar "top-to-bottom" decline (2007-2009) is intriguing.

More intriguing are the implications going forward; specifically, the QQQQ's -20% would require a 25% gain to revisit October 2007 highs. DIA? The -30% requires 43%. A very optimistic outlook might suggest that Nasdaq investors might require 2 1/2 years of favorable waters, while the Dow folks might need 4 1/2 to 5 years.

Many might make the economic argument that the Nasdaq 100 represents the growth stock stories from the tech and biotech space; meanwhile, the Dow Industrials Index tells us more about potential value and conglomerate well-being. I'm not willing to sign off on economic growth as the primary reason for the Dow-Nasdaq performance discrepancy.

For me, it's mostly about the U.S. dollar carry trade's impact. The U.S. dollar's ongoing decline since a top in March 2009 has made U.S. stocks super inexpensive to the rest of the world. What's more, hedge funds and traders use the dollar carry trade to buy riskier assets.

Today, the more the U.S. dollar falls, the better many "so-called" American companies will do. Since a large percentage of them earn more than 50% of their money from overseas operations, profits come in the form of strengthening foreign currencies. The weak greenback, then, is contributing to healthier corporations.

It is ironic, though. Multi-nationals are less interested in making cheap stuff in the developing world than they are interested in emerging nations as a source of revenue; that is, corporations are looking to China, Brazil and others as potential consumers, not as a source of cheap labor.

Are we purposefully growing America by letting the U.S. dollar slip-slide away? The U.S. government may not admit that this is the intent, but we barely hear a peep from officials about actions to reverse the trend. There may even be a small bit of arrogance about the U.S. dollar such that... "Hey, where else is the world really going to turn?"

The threat of a U.S. dollar weakening to the point of absurdity may indeed exist. Still, investors need to think about several possibilities, including the chance that foreigners lose faith in U.S. currency and U.S. dollar-denominated debt.

Right now, though, top-level policy makers must be tallying up the positives:

(1) Weak dollar = smaller trade deficit
(2) Weak dollar = importers forced to buy less from abroad
(3) Weak dollar = exporter competitiveness
(4) Weak dollar = increased profitability of multinationals
(5) Weak dollar = reduced outsourcing overseas... possible boost to jobs?

And that's just the economy itself. Global "reflation" in the form of excess U.S. dollars is the biggest reason for the increased risk-taking in financial markets. People use the negligible interest rate dollar to buy lots of stocks, bonds and higher-yielding currencies.

In fact, all of the world's currencies are trending higher against the dollar:

Popular Currency ETFs Trough 10/9/2009