INVESTING: How to factor weak dollar into investment decisions

The mighty U.S. dollar. There was a time when it really could take you places. When my wife, Sarah, and I went to Rome nine years ago, we felt as if we were stealing clothes from the Italian vendors. We went back a few months ago; the pain was reversed. Our currency is under attack, which is affecting all our lives.

Twenty years ago, the United States did a majority of its international trade with a few large European countries and Japan. NAFTA, globalization and the rise of the Asian economic beast have changed the game. Even lowly Peru is getting in on the act. Globalization is one of the most positive events in recent human history. As recently as 2002, when the dollar was at its peak against most major currencies, it seemed as if America was going to add to its dominance of the world. Well, if dominance is our goal, the price just went up. A lot.

Any discussion of the dollar needs clarification regarding statistics the media pump out. Many headlines claim the dollar fell to multi-decade lows. This is true if you use the out-of-date basket everyone seems to be watching. That basket was established in 1972. Altering it to reflect which countries we actually trade with today puts the dollar at around 10-year lows. That’s still a downtrend, but better than most news reports would have us believe.

I have been advising all year to stay away from small-cap stocks. The numbers consistently support my theory that larger stocks will outperform. Simply look at the returns for the small-stock Russell 2000 and the S&P 500, which includes larger firms. The Russell is up 3 percent and the S&P is up 7 percent so far in 2007. This differential is caused partly by our weak dollar. Our cheaper currency causes the stuff we make here to be more affordable abroad. General Motors was replaced by Toyota in May as the largest car company in the world. GM just took the spot back, because of the cheap dollar.

Large, multinational firms benefit from a weak dollar, but most small-cap companies don’t have the same level of exposure to the international market. In addition, foreign investors will move their investable assets to stronger-currency nations, which means they are selling their American stocks. Even if they are selling only a small portion of what they hold here, it doesn’t take much to drag down the small-cap indexes.

The weak dollar also has played a part in the rising energy market. Oil is priced in dollars, so when the dollar goes down, oil producers want more dollars for the same amount of oil. Oil has gone up much more in price for Americans than it has for Europeans.

Despite the help it provides some big companies, we don’t want a weak dollar. If it continues at this pace another two years, inflation will get out of control.

Betting against the dollar has become almost as popular a financial trade as buying tech stocks was in 1999. This tells me there could be at least an intermediate-term rally coming for the dollar. If that happens, the rally in the stock market could broaden. Keep an eye on it.