Investing In a Strong US Dollar Environment
The last 8 months have seen an overall increase in the value of the US dollar, which has risen almost 25% in value. A strong dollar has many implications on our investments and the future course of our economy. Outlined here are some of these implications: Foreign Investor Dollars Foreign economies have taken a hit recently, leading investors from around the globe to park their investments in the US. Some of the main drivers for this are the strong economic growth that the US has experienced recently, as well as the upcoming, imminent rise of interest rates by the Fed. Foreign economies have been experiencing very little growth, with some countries even seeing negative growth. In contrast, the US economy is projected to grow at a rate of 3.6% this year, allowing foreign investors to expect higher returns and feel confident in investing their money here. U.S. Stocks Historically, U.S. equity markets have performed well in the rise of the US dollar. It’s important to note, however, that individual sectors perform differently during these economic times. Multinational companies carry out a lot of business in foreign countries, making them susceptible to changing economic times. Currently, US companies that see most of their revenue come in from exporting are taking a hit as they exchange foreign currencies back into US dollars. When the dollar strengthens, our exports become more expensive. Since close to half of S&P 500 revenues come from outside the U.S., there’s enough reason to worry about a strong US dollar diminishing revenues simply due to foreign exchange rates. The last column of this chart tells the S&P 500 earnings per share growth in the year following an increase of at least 10% in the value of the US dollar. This data ranges from a decrease of 9% to an increase of almost 30%, proving that there are numerous factors to market performance and returns – a strong US dollar neither guarantees nor predicts the performance of our equity markets, but it can still be used as one of the leading factors for increased returns. The second column shows that the S&P 500 has seen some sort of increase every single year after the dollar appreciated at least 10%, but we should still note that this growth is also driven by other factors.
Commodities Most commodities are priced in dollars, forcing their performance to vary depending on the value of the dollar. The chart below shows the price of oil v the US dollar. You will notice the price of oil will always decrease when the value of the dollar increases. Since the value of oil doesn't change, it wouldn't make sense for the price of oil to stay the same if the value of the dollar increases. Additionally, a rising dollar causes commodities to become more expensive for foreign investors, therefore there may be a decrease in overall demand for them as an asset class and leading to their under-performance. The second chart below shows a relatively strong correlation between the value of the US dollar and a broad commodity price index: as the dollar rises, commodity prices decrease due to a waning demand in the global market for commodities.
Bond Markets When calculating real bond returns, it’s important to take inflation and the value of the bond’s currency into account. As the dollar appreciates, the real return of US bonds increases, making US bonds more popular to international and domestic investors alike. Furthermore, it makes US bonds more attractive in comparison to emerging market bonds, whose currencies are more likely to fluctuate in value and therefore increase the risk of holding those bonds. However, a properly diversified portfolio should still contain some exposure to emerging markets. Bottom Line The fluctuation in the US Dollar is one of many factors that can affect your investment performance and therefore cause a need to review your investment mix. Talk to your financial professionals about how this may affect your portfolio.