NEW YORK, July 14 (Reuters) - More foreign capital needs to flow into the United States to finance the ballooning current account deficit if the dollar is to sustain its recent equity-fueled rally against the euro, currency analysts say.
The dollar has soared around 5 percent against the euro (EUR=) since hitting 4-year lows in June, and several analysts attribute most of those gains to a surging U.S. stock market.
The Nasdaq Composite Index (NasdaqSC:^IXIC - News) and the S&P 500 index (CBOE:^SPX - News) have rallied 55.6 percent and 28.5 percent respectively since Wall Street's low of October 9 last year.
"The market has it wrong. I don't see the dollar sustaining its gains," said Larry Brickman, currency strategist at Bank of America. "The (capital) flows are simply not there. We still have a huge current account deficit and to finance that deficit, we need to attract massive flows," he said.
The current account deficit has swelled to record levels of around 5 percent of gross domestic product, making any kind of economic recovery difficult to pull off. Analysts' estimates show that to bridge the current account gap -- the broadest measure of a nation's global trade -- the U.S. needs to attract at least $1.5 billion in foreign funds per day.
So far, the U.S. is not attracting anywhere near that kind of money, based on equity flows tracked by UBS data.
For the week to July 4, UBS data showed a net $595 million outflow, the 12th in the past 14 weeks. At minus $711 million, the four-week net flow's moving average is at its most negative since March 1999.
Euro zone purchases of U.S. equities, which analysts monitor to track movements in the euro against the dollar, have also been on a downtrend, according to Bank of America's Brickman. The 12-month sum of net equity purchases by euro zone residents into the U.S. peaked in October 2000 at around $115.6 billion. But for the 12 months to the end of April, total European buying of U.S. stocks stood at only $4.9 billion.
European purchases are not expected to grow any time soon, which could put yet more pressure on the dollar, according to David Durrant, chief currency strategist at Bank Julius Baer.
The euro zone is hobbled by sluggish growth, weakening exports, and low productivity, and Bank of America's Brickman said a sluggish European economy is hampering Europeans' ability to invest in overseas markets.
"What normally happens is that as Europeans feel poorer, they retreat from international markets and invest at home," he said.
EQUITY GAINS UNSUSTAINABLE?
Analysts query whether the stock market's gains can be sustained. Some fear its rise may have been simply a 'dead-cat bounce' which can only disappoint as shareholders wait for profits that won't materialize.
Korman Tam, currency analyst at MG Financial Group, thinks current valuations in the stock market have fully priced in a U.S. economic recovery.
"The stock market's upside is certainly limited. I think most of the shares are fully valued," Tam said.
Brian Garvey, currency strategist at State Street in Boston, said in a research note Monday that the price-earnings ratio of the S&P 500 is back to 35, which another analyst said was practically the same level before the stock market collapsed in 2000.
FOREIGN INVESTMENTS PICKING UP?
Still, some analysts see scope for optimism. Michael Woolfolk, global head of North American research at Bank of New York, said that while net foreign direct investment to the U.S. has been trending down, there are signs flows are picking up.
"After a brief bout of U.S. equity selling during the first half of June, it appears that (foreign investors) have started buying again on improving prospects of a U.S. economic recovery," he said, citing Bank of New York capital flow data.
"The initial signs are that the U.S. current account deficit may have peaked and is in the process of recovery, while a weaker dollar encourages renewed foreign direct investment," he said.
Overall, Bank of America's Brickman thinks the onus is still on the current account deficit.
"In essence, nothing has really changed. We see no evidence of a rebound strong enough to fund an over five percent of GDP current account deficit," he said.