But higher rates might snuff the economy, making it even riskier to bet on the buck. Meanwhile, in Canada, Latin America and Southeast Asia, dollar values are steady to strong. These crosscurrents are powerful arguments for the government to do nothing, which seemed to he its stance last week.
Still, the dollar bears keep rattling their cage, helping to drive up rates worldwide. Every country with a financial market is umbilically attached. Those with currencies linked to the dollar tend to raise their own rates to stay in line. Those with emerging stock markets lost the huge flow of foreign money that had propped prices up. Germany’s business recovery came on faster than expected, strengthening the Deutsche mark and spurring fears that European rates will settle at a higher level. In the United States, where inflation paranoia rules, another minirise in rates is expected by year-end. To Gerard MacDonell, of the Bank Credit Analyst’s Interest Rate Forecast, this signals a rationing of credit in a world that needs credit to expand.
Such frightening markets sorely test an investor’s faith in first principles: buy and hold for the long term; diversify; dollar-average, by investing a fixed sum of money every month. Everyone following those precepts has probably lost money this year, while those who sold when interest rose may have kept their capital intact. On the other hand, when prices eventually bounce back, the defectors may reinvest too late. That’s what makes dollar-averaging such a plus. You stay in the market and buy on dips, which should raise your profits over the long run.
One weakness to the buy-and-hold story is that it’s usually proven with stocks. Does it also apply to bonds? When interest rates rise, the value of shares in bond mutual funds immediately heads south. For the past three months disillusioned bond investors have been selling shares, reports Robert Adler, president of AMG Data Services in Arcata, Calif.
I asked Derek Sasveld of Ibbotson Associates in Chicago to look at the bear markets of the past and tell me how bond investors fared. We used intermediate-term Treasury bonds, and defined a bear market as a loss in value of 5 percent or more.
Sasveld found that buy and hold will work as long as you reinvest dividends. When interest rates rise, your dividends can be used to buy bonds that pay higher yields-and eventually, those higher yields make up for the principal you lost. For reinvestors, there have been four bear markets since 1926, none of which lasted very long. Had you bought just prior to each drop, you’d have recouped your money in an average of about 17 months. Your longest wait would have been 25 months, in 1958-60. Stock-market recoveries usually take longer than that.
But it’s quite another story if you’re using your bond-fund income to live on. That’s because, unlike stocks, cycles in bond prices last for decades. Bonds generally rose from 1925 to 1954, declined until 1982 and then rose agin-with the ultimate end of the current cycle not yet known. Had you bought in 1954, it would have taken more than 39 years to recoup your capital loss. So if you’re withdrawing your dividends, it’s safer to won stocks as well as bonds, in order to minimize your risk.
Diversification (also known as asset allocation) still makes good investment sense, even though most markets are currently in decline. Owning different types of mutual funds doesn’t save you from occasionally losing money. But it does save you from having most of your moey in the sectors that happen to do the worst, says Marshall Blume, a finance professor at the Wharton School in Philadelphia. Always assuming that you’ll hold for the long term, diversification should yield profits with less risk.
Diversification, by the way, doesn’t mean owning three growth funds or three bond funds. it means combining different types of funds-U.S. and international, stock and bond. Bonds have been bummers so far this year, but long-term Treasuries currently yield unusually high returns over inflation, points out Irwin Kellner, chief economist at Chemical Bank. George Murnaghan, a vice president of the mutual-fund manager Rowe Price-Fleming International, expects good returns from European stocks, based on higher corporate profits. Brian Hopkinson, a manager of the Van Eck Global Balanced Fund, seconds the motion and adds Japan. Funds focused on the rest of Asia plunged in the first quarter, but then turned up.
A dollar slide, by the way, will improve your investment returns if you hold stocks from the countries whose currencies got strong. The rising yen, for example, helped the Japanese mutual funds perform well this year. Over the long run, fluctuations in currency values tend to cancel themselves out, says Thomas Wittwer, first vice president of Vontobel USA, a manager of mutual funds. But most managers make side bets (called hedges) on the currencies they hold. A good hedge adds profits when the dollar drops and minimizes losses when foreign currencies drop instead.
It’s unknowable whether today’s dollar turmoil will turn into a dollar rout. If not, the fundamentals are strong.
Item: Europe and Japan are emerging from their slumps, which signals synchronous worldwide growth in 1995-96.
Item: Once an attack on a currency starts, the momentum lies with the speculators. But the very same markets that dropped with the dollar could rally smartly when the angst clears.
Item: The U.S. economy feels better than it has in years. As summed up by Lehman Brothers’ chief economist Allen Sinai, “The financial system is in good shape, there’s a boom in capital spending, productivity growth is strong, inflation is quiet, the federal government’s share of economic activity is shrinking and real wages are rising.” So worry if you must, but not too much.
