Dow Rebound: How Foreign Central Banks are Boosting U.S. Stocks

In a global economy, actions around the world can help or hurt stocks. Find out how foreign interest rate policy is helping the Dow.

Feb 27, 2014 at 12:30PM

Since the first trading session of February, the Dow Jones Industrials (DJINDICES:^DJI) have gained more than 850 points, clawing back much of the ground they lost during the previous month. Today's 35-point move up as of 12:30 p.m. EST comes at the same time that the 10-Year Treasury Yield (TREASURY: TC10Y) is down 0.03 percentage points to 2.65% and once again nearing its lowest level this year.

The failure of interest rates to rise has made bonds one of the most surprising winners so far in 2014. But one reason the Dow is doing so well is that the United States is not the only country that is embracing a low-interest rate policy. Bond investors around the world believe that even as some of the more extraordinary central bank monetary policy measures start to fade, accommodative rates will last for some time.

It's not just the U.S.
Many investors believe that the U.S. is the only country that has been aggressive in keeping rates low. But countries around the world have taken similar measures; in fact, conditions in other countries have actually led to more aggressive policy shifts. For instance, Japanese Prime Minister Shinzo Abe's attempts to revive the nation's economy have involved explicit efforts to devalue the once-soaring yen; the result has been a revival for the country's export economy. That has helped Toyota, Sony, and other consumer-product exporters by making their goos more attractive in foreign markets, reversing a long trend that had presented huge challenges to Japan's industrial giants and created the near-constant threat of deflation. Moreover, the policies have been to the benefit of the entire Japanese stock market.

At the same time, Europe has faced more recent economic struggles than the U.S., with the eurozone just now starting to show signs of coming out of recession. As a result, the European Central Bank has continued to keep rates low, and investors have expected that the ECB might indeed cut rates further in order to ensure a margin of safety to avoid a double-dip recessionary event. At its most recent meeting, the ECB chose not to make additional reductions, and that lifted the value of the euro against foreign currencies such as the U.S. dollar.

Forex and you
But the impact of foreign interest rate policy goes beyond currency exchange rates and bonds. It also has important long-run implications for the Dow.

For many Dow components, exchange rates are a direct driver of profit. McDonald's (NYSE:MCD) gets a huge portion of its overall revenue from its overseas restaurants, and a strong U.S. dollar in recent years has played a role in its relatively sluggish growth. Similarly, Procter & Gamble (NYSE:PG) has worldwide brand recognition, and doing business in just about every nation in the world, P&G has to deal with the challenges of earning income in foreign currencies of all types.

If the Fed were the only national central bank looking at potential changes to its monetary policy, it could promote dollar strength to the detriment of McDonald's, P&G, and other Dow stocks that rely on foreign revenue to a substantial extent. But because of the almost competitive efforts among central banks to come up with the best solutions for their respective constituencies, it's possible that low rates both in the U.S. and abroad could still be consistent with a rising Dow Jones Industrial Average well into the future.

The biggest winners from low rates
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Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends McDonald's and Procter & Gamble. The Motley Fool owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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