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February 4, 2010 Thursday 12:01 AM EST
SECTION: NEWS & COMMENTARY; Commentary; Simon Constable
LENGTH: 421 words
HEADLINE: Good news and bad news on tax increases
BYLINE: Simon Constable
NEW YORK (MarketWatch) — The Obama administration’s plans to raise taxes and cut spending will likely hurt the still-fragile economic recovery. But it could also help strengthen the U.S. dollar.
Here’s why and how to make some money.
“All tax increases and spending cuts dampen growth,” explains Kurt Karl, chief U.S. economist at insurance giant Swiss Re. in New York.
In economic parlance, it is called a “fiscal tightening.” What it means is that both public and private consumption will decline. Private consumption will be down because higher taxes mean lower after-tax income. Public consumption will be down because the government will be buying less.
Other things being equal, investors should expect stocks in general to suffer in such an environment.
However, there is some good news.
“While the tax hike will be bad for overall markets, it is a positive for the overall fiscal story of the Untied States,” says Ashraf Laidi, chief market strategist at CMC Markets in London. “That positive may be felt by the dollar.”
If you buy the argument that the greenback will rise then the easy play, but likely not a huge one, is to buy the PowerShares DB US Dollar Index Bullish exchange-traded fund (UUP) , which tracks the value of the greenback relative to other currencies. The problem is that even big moves in the foreign-exchange market aren’t typically very big compared to those in stocks.
Possibly the better move is to look at the likely winners and losers in stocks.
The clear losers will be commodity and energy stocks that have revenue denominated in dollars. Such companies include Freeport-McMoRan Copper & Gold Inc. (FCX) and Exxon Mobil Corp. (XOM) .
Chip Hanlon, president at Delta Global Advisors in Huntington Beach, Calif., doesn’t necessarily believe the rising-dollar thesis, but he says if you do, the first thing to do is to dump foreign stocks.
Identifying the winners is trickier. Small-cap stocks tend to do well under a stronger dollar, says Jack Ablin, chief investment officer at Harris Private Bank in Chicago. The theory goes that such companies are generally domestic players that import goods either to resell or as components. Either way, a stronger dollar makes those items cheaper.
Ablin points to the iShares Russell 2000 Index Fund (IWM) as a good proxy way to play that theme.
As always, investors need to drill down on investments and evaluate the risks themselves.
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