The strong dollar and investing
On the 19th, we had set new highs in both the S&P500 and the Dow Industrials. The 26th had the Dow down just less than one percent from there; the S&P lower by just less than one and one-half percent. Basically, no meaningful amounts. A lot of the intra-week trading swings seemed to be due to end-of-quarter portfolio adjusting and profit-taking from a number of the so-called momentum stocks, all stirred up by a few rogue headlines.
More good economic news and trends here in the US were offset by the ongoing challenges in Europe and Japan in getting their respective economies to improve. Both the Euros and the Japanese are now trying to do their own respective forms of the easing that the Fed is winding down here. As a result, those interest rates are moving lower while ours are moving higher.
In a report this week, Goldman Sachs Asset Management predicted that “10 year US Treasury Note yields may rise to as high as 4% over 12 months as the end of quantitative easing adds more interest rate risk to the market.” (The 10 year closed at 2.53% Friday.) Whether they go that high that quickly or not, I think we can agree that the trend for US interest rates is up.
One of the main results?
The dollar is stronger
Stronger in this sense generally means three things.
First, it’s stronger since our interest rates are higher and money comes to where it’s treated best. This is making US dollars a highly preferred investment. This was evidenced this past week when we saw three rather significant indicators reinforce the trend. Last Thursday, the US Dollar Index moved to a four-year high. As a result, the dollar is at an 8 year high v. the yen and a 2 year high v. the euro. With those central banks moving to ease, it’s likely that these spreads could widen further.
The next significant factor is that the stronger buck works in favor of those of us buying imported goods, such as vehicles and energy, and not as well for exporters. Also great for travelers going outside the country.
Finally, it has a mega-effect on commodity prices. The major commodities of the world, and most of the not-so-major ones, trade in dollars. So, as the dollar rises/strengthens, those items become cheaper for us and relatively more expensive for others. This can help reduce global demand for these goods.
How does that affect investing?
Let me quote Jonathan Golub from RBC Capital. He wrote that, “Conventional wisdom holds that a stronger exchange rate is likely to be a headwind for stocks as US products become less competitive abroad. Our research suggests this is not the case: (1) the economy and the dollar tend to move in tandem, which means that a stronger economy should result in dollar strength; (2) a rising dollar is supportive of higher (P/E) multiples.” In American, a stronger dollar is likely to be both an economic and market positive. According to FactSet, since the late-1970s, the stock market has performed twice as well during dollar bull markets than during dollar bear markets.
Related to the rising dollar is the fact that the accompanying interest rate rise is not good for fixed-income issues or the bond-equivalents of utility and telecom shares.
I thought he summarized it well. The economy is starting to roll nicely. Put that together with rising rates, and, for some time anyway, the dollar strength should continue.
I say that because I think this is a trend, not a short-term event. If that’s the case, then let’s consider those sectors and areas where benefits can be derived from the trend.
How about the industrial sector first?
Materials costs
The biggest expense for most manufacturers is the cost of the materials needed to make their stuff. One of the biggest sub-expenses is energy – however it gets used. And in the US, we have a couple really good trends underway in this regard.
First, since the energy (natural gas; crude oil; refined products) is bought in dollars, we will be paying less for imports. With fracking adding amazing amounts of product our storage facilities daily, we also benefit from increasingly less dependence upon foreign sources…though our biggest foreign suppliers are Canada and Mexico.
The other is that the dollar strength is making the energy costs higher elsewhere…as well as their costs for other basic materials. This can help domestic firms gain market share over time.
So, think of all the types of major firms, suppliers, vendors, etc., and not just in the energy field, that can see growth as a result of this broader expansion.
Other areas?
Historically, when we’re in the early stages of rising interest rates, notes that rise and fall with prevailing short-term rates, i.e., floating-rate, (or funds made up of these) are attractive due to their being less volatile than many fixed-rate investments.
And, as I’ve been saying for a while, the cyclical part of the market should do well. This is the one that responds fairly readily to the overall direction of the economy. So, as we gain speed, look at the big-name tech, energy and materials space for inspiration.
Please recall two things. Volatility is a friend of the bull – there’s lots more of it in a rising market due to lots more trading being done.
The other is a quote from Warren Buffett to keep in mind when or if the market turbulence starts to rock your portfolio. He said, “The stock market is designed to transfer money from the active to the passive.”
Cheers!
Mike
509-747-3323
Securities and Investment Advisory Services offered through KMS Financial Services, Inc.
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Past performance is not indicative of future returns.
Investing in securities of any type involves certain risks, including potential loss of principal. Investment return and principal value in a bond and/or securities portfolio will fluctuate so that investments, when sold or redeemed, may be worth more, or less, than the original investment.
Investing in sectors may involve a greater degree of risk than investments with broader diversification. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.
