Best to Diversify Outside the U.S. Market

Since March, 2005, the U.S. dollar (USD) has risen against both the Yen and Euro. Some are optimistic that this trend will continue, but there is currently some hesitancy surfacing on the price charts as the USD is facing some selling pressure.

In my view, I believe the USD will face selling pressure and could reverse course to the downside. You should realize this and keep this in mind when trading or investing.

The outlook for the USD was made worse earlier this week when President Bush presented a $2.77 trillion spending plan to Congress to focus on combating terrorism.

But, here is the problem. The significant spending is at a time when the budget deficit is expected to touch an all-time high of about $423 billion this year. The White House did add that it planned to reduce the deficit over the next five years to about half of the current deficit by the time Bush leaves Office in 2009. But, pundits argue that extending tax cuts will push the deficit to over $1 trillion from 2012 to 2016.

 The rising budget deficit could inevitably lead to a weaker USD as the demand for U.S.-denominated assets declines. For investors, this means holding U.S. stocks may produce added risk should the USD begin to falter going forward.

 The key is to minimize the risk. You could do this by holding some foreign assets. For example, those of you holding investments in Canadian stocks have benefited. The main TSX index in Canada touched a historical high earlier this week due to strength in energy and gold stocks, a key component of the TSX. In addition, the Canadian dollar has done well against the USD since January, 2003. In the last two years, the Canadian dollar has climbed steadily from US$0.65 to the current US$0.87. By holding Canadian assets, you would have made a nice from the rising Canadian dollar.

 Geographically, you could also invest in such places as Japan, India, and South Korea, all of which have had some strong market gains over the last few years. In these countries, I would look at stock mutual funds or Exchange Traded Funds (ETF) as a safer strategy than buying individual stocks or ADRs.

 Another way of hedging against a decline in the USD is to buy foreign bonds denominated in other currencies. Canada is an ideal place for good quality bonds.

 So, however you do it, diversification is an important strategy for your portfolio. If the USD begins to trend lower, you need to be have some assets denominated in other currencies.