Why has the dollar been on the rise in recent months? Is a strong dollar good or bad for investors?
The dollar is rising as the U.S. economy improves on the back of higher employment and increased trade. And while the Federal Reserve has signaled that it’s looking to raise interest rates, the European Central Bank just started an asset buying program, pushing the euro down compared to the dollar.
The U.S. economy may not be as strong as we’d like it to be, but it’s still growing faster than most of the economies around the world. This outperformance compared to other currencies looks to continue at least through the end of 2015.
But what does this mean for investments? There will likely be some winners and some losers.
Best Investments for a Strong Dollar
Here are the most likely winners if the dollar continues its rise:
- Consumer Cyclical Stocks: A strong dollar has the positive effect of keeping inflation relatively low, which can put more money in the pockets of consumers. Consumer cyclicals especially benefit from lower prices of imports and lower prices for commodities, such as oil, which are traded globally, and mostly in dollars.
- U.S. Mid-Cap Stocks: Mid-sized U.S. companies may be the sweet spot of investing now. Many large U.S. companies are big exporters that will be hurt by a stronger dollar, which makes U.S. goods more expensive abroad. But mid-cap stocks are not typically at the multinational stage yet. Small-caps could be riskier in the latter stages of a bull market.
- U.S. Fixed-Income Assets: Although the Federal Reserve is mulling a rate hike, a stronger dollar can ironically help maintain its accommodative stance with monetary policy for a longer period of time. This could in turn be positive for U.S. bonds and bond mutual funds.
Worst Investments for a Strong Dollar
Here are the most likely losers if the dollar continues its rise:
- Commodities: Oil and gold are denominated in U.S. dollars, so a stronger dollar pushes down the prices of these commodities. Steer clear of commodities funds, especially those with heavy exposure to oil, precious metals and mining companies.
- Multi-National Stocks: Big, multinational companies with significant operations overseas could get hit with lower profits because of a disadvantageous currency conversion. In simple terms, the companies have to translate foreign earnings into stronger dollars, which may be all it takes to miss earnings estimates in the next quarter.
- Emerging Markets Stocks: Many emerging countries, such as Brazil, Venezuela and Argentina, just to name a few, are either producers of commodities or have debts denominated in U.S. dollars (or both). This has a negative impact on emerging stocks in a rising dollar environment. And if their currencies are dropping in relation to the dollar, it has an even bigger negative impact on their economies.
On a final note, the relative strength or weakness of the U.S. dollar is not an isolated factor that significantly impacts a diversified portfolio, especially for long-term investors. Furthermore, currency fluctuations are complex and difficult to forecast. Therefore, it is not advisable to make big moves either way on dollar moves.
As of this writing, Kent Thune did not hold a position in any of the aforementioned securities. Under no circumstances does this information represent a recommendation to buy or sell securities.
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