Outside the Box: Dow soaring; dollar sinking

Trying to understand the financial markets is similar to a man trying to figure out a woman. And like a woman, the markets are beautiful, complex and do not always react the way you expect them to. Here in the Philippines, the peso is strengthening on an almost daily basis to levels not seen in years. The economy is strong. We have a stock market poised to reach a historic high. In the US, the dollar is near a historic low against the euro and the long-time low against the British pound. The economy is showing signs of weakening on several different fronts and sectors. The Dow Jones Index and the broad market are breaking to prices never seen in its 200-year history. Two almost completely different economic scenarios and yet both countries have booming stock markets. Conventional wisdom says that stock market prices rise during good economic times. Business being good and companies making money lead to higher prices. If that is true, then shouldn’t the Philippine market be a little more tentative as the economy is still way below desired growth levels? And shouldn’t the US market be falling or stagnant at best? The dynamics of stock price movement are much greater than simply a broad look at business and the general economic conditions. The pivotal point of the value of any investment is the corresponding value of “money.” The value of money is best determined by the cost of money or interest rates and the “supply” of money in the economic system in question. Look at the Philippines. The Philippine Stock Exchange is rising not so much based on business activity and climate but because of historically low interest rates. Low interest rates are making it more attractive to invest in stocks than to keep money in the bank. Stocks and bank accounts are similar investments because they are both immediately liquid and convertible in hard cash. Therefore, an investor makes a decision whether he can make more money depositing funds in a bank or buying stocks. Because interest rates on bank deposits offer so little return, the stock market is a very viable alternative. Two factors determine the price of a currency; trade flows and interest rates. If a nation exports and sells more than it buys and imports, there is a flow of foreign currency into the economy making the home currency stronger. Likewise, if interest rates are high in a particular country, foreign currency flows in making the home currency appreciate. Here in the Philippines low interest rates should actually keep the peso price depressed. Also, a less than outstanding export flow should keep the peso down. However, between the more than $12 billion of OFW money coming in and the $3.5 billion of outsourcing funding, all that cash inflow is appreciating the peso. Lots of cash combined with low interest rates will push the PSE to record levels. Now the US is a different story. Regardless of any potential weakness in the economy and lower profits, US interest rates are low, and predicted to move lower. Therefore, a stock market investment looks quite attractive. But why is the dollar going down so severely? While inflation and interest rates are low in the US, Europe is facing an interest-rate increase. Inflation in Europe is raising its ugly head and the European central bank is poised to raise rates. Therefore, there is a movement out of the dollar and into the euro to take advantage of making more money in euro bank deposits. Further, a strong euro lowers US demand for European goods. This will cause the euro economies to falter while at the same time potentially raising expectations for the US economy. Further, with a weak dollar, foreign money is moving into the US stock market because prices in New York are lower than previously when measured in foreign currency terms. Dollar down, market up. Peso up, market also up. Will these two markets continue to push higher? Yes, as long as their respective national interest rates stay low. Will the peso continue to appreciate while the dollar moves lower? Yes, as long as money continues to flow into the Philippines and out of the US.  E-mail comments to mangun@email.com

 

http://www.businessmirror.com.ph/04242007/opinion02.html