Dollar Bulls and International Bears

The greenback is back!

That’s right, the value of the U.S. dollar versus rival foreign currencies has surged during the past several weeks, and that surge has caused quite the dust up in the international equity markets.

Just five weeks ago, the dollar had been languishing at record lows against the euro. But last week the dollar hit a six-month high against the euro and a two-year peak against the U.K. pound sterling.

The chart here of the U.S. Dollar Index tells a revealing story.

So, what explains the quick turnaround in the greenback’s fortunes?

I think the basic reason is that the economies of Europe are slowing way down. In fact, the eurozone economy now is flirting with recession. To see the evidence of this we need simply to examine the numbers. The 13-nation eurozone economy contracted 0.2% in the second quarter. That was the first decline since before the euro’s introduction in 1999, with the economies of Germany, France, and Italy all contracting.

Furthermore, inflation in the eurozone is running at almost double the European Central Bank’s (ECB) target rate, which makes it unlikely that the ECB will cut interest rates anytime soon. The result is that both European economies and the euro are likely to fall on hard times for a while.

Of course, the other result of the dollar’s surge has been a sharp sell off in international equities. Just look at the recent plunge in one of the biggest international exchange-traded funds (ETFs), the iShares EAFE Index (EFA). Year-to-date, EFA is down 20.9%! Now that’s what I call an international bear.

Surprisingly, EFA actually is one of the best-performing international funds so far in 2008. The iShares MSCI Emerging Markets (EEM) has plunged 21.6% this year, and big international markets like China, as measured by the iShares FTSE/Xinhua China 25 Index (FXI), have collapsed 30.6%.

But it’s not just international ETFs that have been hit so hard this year. International equity mutual funds also have languished. Three of the biggest international mutual funds are the Oakmark International fund (OAKIX), down 19% for the year; Fidelity Advisor Diversified International (FDVAX), down 20.3%, and the Bernstein International Portfolio (SIMTX), which has fallen 23.1% year-to-date.

Not surprisingly, all three of these funds are on my Lemon List, the list I compile of America’s worst-performing mutual funds.

The bottom line is that when the dollar is in a bullish climate, international equities tend to turn bearish.

Fortunately, investors who follow my Successful Investing advisory service escaped the rapid decline in international stocks before this year’s steep descent. How did we manage to do this? Simple, we always have a plan in place to protect ourselves from falling markets — both foreign and domestic.

Want to find out how you can protect yourself from any kind of bear market?

Click here to learn more about Successful Investing.