Word: euros
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...there's a rub. Americans are more tied to the stock market than ever, and most of their holdings are of large U.S.-based companies. As the euro slides, so does the profit picture at those kinds of companies. Why? They do business across the globe. When the foreign currencies they are paid in lose value against the dollar, that translates into lower profits at home...
Last week Kodak warned that the weak euro, coupled with higher energy prices, will mean disappointing earnings this quarter. Its stock plunged 25%. The previous week Intel issued a euro-related warning, and its stock crashed 22%. McDonald's, Gillette and Goodyear have all cited the slumping euro as cause for a diminished-profit outlook. Others will follow...
...trying to invest around the weak euro, avoid companies with extensive operations abroad. Those tend to be consumer-product giants like Colgate-Palmolive and Procter & Gamble, typically thought to be defensive investments. Tech stocks fall into the same trap. Even those without European operations aim to benefit from business there. Your salvation may be in oil, natural gas and electric utilities. Although they've run up, these stocks look best from a risk-reward point of view...
...euro's decline hasn't pounded the U.S. market too hard because traders have been focusing on just one aspect of it: vaporized earnings as euros are converted to dollars. But there's a second shoe that might drop. Oil is sky high, and because oil is priced in dollars, the toll has risen way faster in Europe. The spike could trigger a dramatic slowdown that spills across the pond as U.S. earnings erode...
That threat is partly why the U.S. is intervening in the currency and oil markets. But Uncle Sam can't be too aggressive. If the euro rallies, billions in foreign investment would leave, undercutting U.S. stocks. "We're walking a tightrope," says Gail Dudack, strategist at UBS Warburg. And that's why a little caution makes sense...