The greenback is looking strong, but there’s no reason to believe that it can’t get even stronger. If it does, then it will have an impact on your investments. Here’s why it matters and some key things you need to know.
“It’s the kind of thing that Americans don’t think about much unless they travel overseas,” says Eddy Elfenbein, a Washington, D.C.-based private investor and author of the influential Crossing Wall Street blog. But when the dollar is strong, it does change the way various types of investments perform. “It’s like putting a magnet near a compass,” he says.
In other words, the value of your assets could start spinning when the dollar moves.
The rally in the dollar stalled in March, having appreciated more than 20 percent against major currencies starting in July 2014, according to data from the Federal Reserve Bank of St. Louis. But the upward trajectory could easily continue because while the U.S. economy isn’t roaring, it’s in better shape than the rest of the world — just look at weakness in China, the commodity economies of Canada, Australia, Brazil, as well as the mess in the eurozone.
One of the big problems for companies that have large overseas operations is that a stronger dollar makes those foreign sales look smaller. S&P Dow Jones Indices estimates that slightly less than half of sales for Standard & Poor’s 500 index stocks come from outside the U.S. So when the greenback is stronger, sales and earnings of foreign-focused companies start to wither — typically it’s not something that Wall Street looks favorably on and share prices of the companies affected can get hammered.
So what do you do to dodge that investing bullet? Avoid mega-cap companies that have truly global operations, such as The Coca-Cola Co. (ticker: KO) or McDonald’s Corp. (MCD). Both have substantial overseas sales.
Instead look for smaller, more domestically focused companies like many of those in the Russell 2000 index, says Steve Wood, chief markets strategist for Russell Investments. “U.S. growth is far more important to smaller domestic companies than currency issues,” he says. The iShares Russell 2000 exchange-traded fund (IWM) holds a basket of stocks that tracks the Russell 2000 index.
Such a basket approach may be better for many smaller investors wishing to stay in stocks because analyzing foreign sales isn’t always simple. More than half the companies in the S&P don’t disclose much data on their foreign sales, says Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. The analysis mentioned earlier is based on those companies that do disclose.
Although sales are sometimes broken out by region, where the costs come from are rarely provided, Silverblatt says. That makes understanding the currency impact ahead of time hard.
One thing that we do know is that those businesses that make money selling hard assets, like energy and metals, can have a hard time when the dollar is strong, Elfenbein says. “When the dollar goes up, energy and materials stocks go down.” There are reasons to own such companies, but it may not pay to have more than you need in your portfolio.
Stocks that could be less susceptible to currency moves are more likely to be in health care and utilities sectors, Elfenbein says.
Of course not all investing involves U.S. stocks. Elfenbein notes that because a rising dollar is like saying “America, we like you, let us give you our money,” it tends to mean that bonds do well. Investors parking their money in greenbacks may simply purchase treasury bonds, bidding up prices and driving down yields. Interest rates and the price of fixed-income securities move in opposite directions. Another important thing in the bond market is that when the treasury prices rally, it may also help lift the values of corporate bonds.
Unfortunately, there is the other end of that story, which means that while money is pouring into the U.S. bidding up the greenback, it is leaving somewhere else. “It could devastate the emerging markets,” Elfenbein says. “When money moves, a trickle can become a flood instantaneously.”
Emerging markets such as Thailand, Malaysia and Russia might see capital fly out of their economies in the event of a big surge in the dollar, hurting stocks in those countries. For that reason, stocks like those held in the iShares MSCI Emerging Markets ETF (EEM) might get disproportionately hit.
Wood says that while U.S.-based investors would benefit from focusing on domestically oriented stocks, the opposite is the case if you are based overseas, say in Germany or Japan. If the dollar is strong, its likely that the euro and the yen are weak.
Such currency weakness in those cases would favor export-led companies in those countries. That’s because weaker currency makes the price of the goods cheaper in U.S. dollars. Car manufacturers BMW (BMW.de) and Toyota Motor Corp. (ticker: TM) might do well for investors based in Germany and Japan, respectively.
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How to Buy Stocks When the Dollar is Strong originally appeared on usnews.com
