Spokane Journal of Business

What a stronger U.S. dollar means to investors

Currency dynamic should be good for stock market

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After a weak start to 2014, the U.S. dollar muscled its way higher this summer, and the gains look as if they may be continuing.

Investors from all over have been eagerly jumping into the U.S. markets. The strengthening dollar has been remaking the investment landscape as the U.S. Federal Reserve is ending quantitative easing and is on the verge of raising interest rates. 

At the same time, many investors are betting the euro and yen have further to fall, as economic expansion falters in Europe and Japan while our growth gathers more momentum. The economies of Europe and Japan remain frail and inclined to loosen monetary policy rather than to tighten it. The European markets have been sliding downward, as if they’re in a time machine and living through our bad economic experiences of three years ago. And China is consolidating, which means less demand for commodities.

A stronger dollar has various effects. But the main one is that, all else being equal, it means tighter global monetary policy. What do I mean by that?

The dollar is the world’s reserve currency. In other words, it’s the most widely used and most important currency in the world. Whether relatively weak or strong, it’s true. The world needs huge numbers of dollars to do business day to day. Consequently, if the dollar gets more expensive, so does the cost of doing business for many companies and countries. Put another way, a stronger dollar is like a global interest rate hike.

I believe the primary driver for the dollar’s strength is that we have a broadly strengthening U.S. economy – especially as compared with all the other major economies. As a direct result of that, we have the Federal Reserve moving toward normal monetary policy as opposed to other global central banks, primarily the European Central Bank and the Bank of Japan. Both of them are still aggressively easing their policy. A direct result of the stronger growth and higher interest rates is to make the U.S. more attractive for investments.

A strong dollar isn’t inherently bad for U.S. earnings, trade, or stocks. There’s no link I’ve been able to identify between the relative strength of the dollar and earnings growth. Sometimes they move together; sometimes they don’t.  The good news, according to FactSet, is that a stronger dollar is likely to be positive for both the economy and market. Since the late 1970s, the stock market has performed twice as well during dollar bull markets than during dollar bear markets. 

Yes, a strong dollar, all else equal, does makes our exports pricier. But, the reverse is true for imports. A strong dollar means cheaper imports, such as ingredients, parts, services, and resources—all of which are synthesized into thousands of value-added products made daily in the U.S. For most U.S. firms, this will help cancel out most of the impact of currency swings. Production can get cheaper as a result, offsetting much of the negative effect from pricier exports. And remember, it also makes foreign travel cheaper.

The same is true for the dollar and trade. While it can be a fringe factor, a weak dollar doesn’t make imports sink and exports rise on its own. Nor does a strong dollar automatically make imports jump and exports crater. 

If the dollar’s relative strength were really a major factor, one would expect imports and exports to move in opposite directions as the dollar is a headwind on one and a tailwind for the other. Trade has much, much more to do with an economic cycle. 

Investing in a strong dollar world

Here’s how I think this time of a stronger dollar will affect different investing sectors.

The most visible area certainly has been the commodity space, most noticeably with regard to oil and gold. While global demand drop has caused lower energy prices, we also have our energy production soaring, and we’re not importing as much of the black stuff as we used to. All that oil has to go somewhere, so the big producers have to cut prices.

I think the strong dollar is the bigger factor behind the drop. As the dollar strengthens, U.S. interest rates rise relative to those of other countries, and this rise tends to push all commodity prices down. This, together with the apparent winding down of the recent overall commodity super-cycle, is causing traders and investors to close those positions and try to get better returns in U.S. assets.

While energy prices are the lowest in some time and energy-related shares have dropped as a result, neither Europe nor China is likely to stay down for an indeterminably long time. I’d be looking at the high-quality energy and oil services companies either to add to or to take new positions on. With the dividends that most pay, you can afford to be nicely patient while you wait for the oil price to begin rising again.

With their costs of goods dropping as the dollar rises, many companies in the cyclical sector—those tied to how well the overall economy is doing—should do well. I maintain that those in the industrial and tech sectors should particularly benefit. I’d focus more on the bigger names now instead of the small-cap firms, as the latter tend to do best at the start of a market recovery.

Is the strong dollar bullish or bearish for stocks? The short answer: relatively bullish. We have some similarities between today’s markets and those in the mid-to-late 1990s. One of those similarities relates to the positive correlation between stocks and the dollar that existed then—and I believe exists now.

Low inflation is historically great for stocks. Helping to keep it low has been these falling commodity prices, courtesy of both weak global growth and the strengthening U.S. dollar. It seems to me that our positive economic growth trends and the low inflation should help support positive stock prices for some time.


Michael Maehl is an independent financial adviser and Spokane-based senior vice president of Opus 111 Group LLC. He can be reached at 509.747.3323 or m.maehl@opus111group.com.

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