Two British stocks to buy as the dollar rebounds
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Associate Editor
David Stevenson Jan 18, 2010
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The US dollar is on the comeback trail.
That may sound unlikely. Most investors seem to hate it. They've been dumping it heavily for months.
But all of this could be about to change. We explained our fundamental reasons for expecting a dollar rally this year two months ago, (What could drive the dollar higher?) so I won't repeat them all here.
So what would a higher dollar mean? The price of most other assets would be likely to suffer, as we point out below. But the good news is that a stronger dollar would leave some companies here in Britain sitting pretty...
Why the dollar is so weak
The US dollar was friendless for almost the whole of 2009. Its 'trade-weighted' exchange rate - based on the business done between the States and its trading partners - fell by 17% between early March and the end of November last year.
Currencies often provide a useful snapshot of a country's economic and financial health. So the weak dollar isn't exactly a vote of confidence in the US.
But of course, America is hardly the only part of the world in a big hole. The thing that's really singled out the greenback for a kicking in the foreign exchange markets is its sheer size. The vast number of dollars sloshing around the world has made the currency the easiest target of the 'carry trade'. This is where investors sell the dollar short, i.e. they borrow bucks at near-zero interest rates. They then plough the cash into higher-yielding currencies or assets.
The trade has seemed like a no brainer. But now there's a snag. Asset prices have risen and the returns available have fallen, making the trade less attractive. And with so many big players on the same side of the same trade, the supply of dollar sellers is running out. And it won't take much more to make them very jittery.
Even rumours of a rise in US interest rates, which would make borrowing in dollars more costly, could provoke a whipsaw move in currency markets. The buck could then bounce very sharply and very quickly. For example, Marc Faber – aka "Dr Doom" - recently forecast a short-term rise in the dollar against the euro of between 5-10%. As most commodities are priced in dollars, their prices would most likely drop, along with many of the shares that have soared recently.
A bounce for the buck wouldn't be bad news for everyone
But a rising American currency wouldn't be bad news for everyone. Those non-US companies which make large chunks of their profits in dollars would benefit as the latter get converted back into their local currency. Also, if these firms are big exporters to the States, the prices of their products will become cheaper in dollar terms, which should help their top-line sales growth, too.
And this particularly applies to many businesses in Britain. Over 50% of the money made by FTSE 100 firms is generated either in dollars or in currencies pegged to it (such as China's yuan). The pound has been quite fragile even against the generally weak dollar over much of 2009. That's one reason why the UK's main blue chip index has done so well since last March, despite our national finances being as dodgy as they are.
So is this another no brainer – you simply buy big dollar-earning UK stocks if sterling looks as if it's likely to fall against the buck?
Well, it's not quite that simple. Higher-than-expected profits when measured in pounds will help to shield a stock price to some degree. But even if the profits of a British firm do get a big currency boost from a lower pound/dollar rate, that won't stop investors placing a lower valuation, i.e. a reduced p/e ratio, on those earnings. In other words, if stock markets fall across the board, then the company's share price could well still drop back anyway.
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Two stocks to buy as the dollar rebounds
So I want to see three extra factors to add in some extra price protection. First, I want to see a p/e multiple that's already some way less than the market's current average of around 18. In short, I'm looking for a cheap stock. Second, a dividend yield that's at least 25% higher than the overall market level of around 3.25%. And third, a business that's in a 'defensive' area, i.e. one that doesn't depend on economic growth to make its money.
National Grid (LSE: NG), at 643p, ticks all the boxes. Why? It's cheap, selling on a p/e of 11 for the current period to end-March 2010. That's forecast to fall to 10.8 for the following year. It's yielding almost 6% at present, which is predicted to rise to 6.4% in 2010/11.
Also, it's a classic defensive stock. The group owns the high-voltage electricity transmission network in England and Wales, and owns and operates Britain's high-pressure gas system. As Ronan Carr of Morgan Stanley points out, it's an almost wholly-regulated utility with very limited risk and no exposure to falling gas and power prices.
And crucially, around half of its business is in the US. National Grid looks good now. A dollar bounce would make it an even better bet.
Another in the same category is the drug maker GlaxoSmithKline (LSE: GSK). Last year Glaxo derived some 45% of its revenues from the US. At 1,250p, on a p/e of just above ten for this year, and a prospective yield of over 5%, it's another classic cheap, decent-yielding, defensive dollar earner. That's just about the best mix of traits to be found in the UK market right now.
Our recommended article for today
Drilling for oil will soon begin in the seas around the Falkland Islands. And if oil is found, those involved will reap huge rewards. Here, Tom Bulford looks at four of the firms hoping to strike it rich in the South Atlantic.
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