Unless you’re planning to visit Europe, why should you care that the US dollar is soaring or that its value against some other major currencies has reached the highest levels in 11 years?
Here’s why: The remarkable shifts in global currencies over the past several months have far-reaching effects on US and global economies as well as on your wallet and investments. Among the effects are cheaper imported products…lower mortgage interest rates…and sharply reduced profits that drag down stock prices for some companies (while other companies see higher profits). Bottom Line/Personal asked global investment expert Paul Hickey why the dollar is so strong, where it’s headed and how you can take advantage…
WHERE IT’S HEADED
The dollar’s gains have been dramatic. The US Dollar Index, which measures the dollar’s value against a group of six major currencies, including the euro, Japanese yen and British pound, has increased 20% since last May. If someone bought something with one euro in May, it was the equivalent of spending $1.39. Recently, that same one-euro purchase cost just $1.13…and before long it may cost a mere $1 or less, which would be the first time since 2003 that the euro was trading at parity with the dollar.
The dollar’s gains reflect the relative strength of the US economy and investment markets, especially compared with Europe and Japan. The gains also reflect the fact that central banks ranging from Japan, Australia and Canada to the eurozone are pushing down already-low interest rates to strengthen their economies while the US Federal Reserve is preparing to raise rates. And the gains reflect the fact that the US currency is considered a safe haven compared with many other currencies. All that increases demand for the US dollar, pushing up its value.
And there is plenty of room for the dollar to continue to gain strength. The dollar index was 28% higher in 2002.
THE EFFECT ON CONSUMERS
Even if you don’t travel abroad, a strong dollar lowers the prices of many everyday purchases, leaves you more for discretionary spending and helps keep down the US inflation rate. What you can expect…
• Cheaper imports, including clothing, electronics and alcoholic beverages.
• Low oil prices. Although the plunge of more than 50% in oil prices and the resulting drop in gasoline and heating oil prices reflect a global oil-supply glut, the strong dollar has magnified the effect for US consumers because the financial markets price oil in dollars.
• Low interest rates on home mortgages. Mortgage rates are heavily influenced by the movement of yields on 10-year US Treasury bonds. Those yields have dropped as investors have piled into them because Treasury interest rates have been more attractive than rates on foreign government bonds and provide a safe haven. The average interest rate on a 30-year fixed-rate mortgage has dropped from 4.5% last spring to a recent 3.6%.
Even though some companies are hurt by a strong dollar (see below), the positive effects of a strong dollar on consumers can help strengthen the overall US economy and various individual companies that gain more consumer revenue. Historically, a strong dollar has been good for the overall US stock market. Since 1965, whenever the dollar index gained more than 10%, as it did in 2014, the market closed higher the following year, with an average return of 15%. The following types of companies are attractive now…
US companies that have one or more of the following characteristics: They have little or no dependence on foreign revenue…they benefit when consumers feel flush and buy or use discretionary products more…and/or they import goods or raw materials to make products, which means that their profit margins rise because they pay less for those imports.
Examples: Capital One Financial (COF), one of the nation’s largest credit card issuers, and regional bank PNC Financial (PNC), a big mortgage lender…drugstore operator CVS Health (CVS)…The TJX Companies (TJX), a big importer and the largest US bargain-priced apparel and home-fashion retailer…Cablevision Systems (CVC), a major cable-TV provider, with 3 million subscribers…and AutoNation (AN), the largest US auto dealer.
European and Asian exporters that do much of their business with the US. Reasons: They are paid in strong US dollars, which means that their revenue gets a boost when it is translated into their home currencies. Also, their goods in the US may have a price advantage compared with goods offered by US-based competitors. Examples of attractive foreign stocks listed on US stock exchanges: Diageo (DEO), the UK manufacturer of alcoholic beverages including Jose Cuervo tequila and Smirnoff vodka…Honda Motor Co. (HMC) of Japan…and Unilever (UN) of the Netherlands, with brands including Knorr soups, Lipton teas and Dove soaps.
INVESTMENTS THAT ARE HURT
The strong dollar hurts some US companies that export products from the US and/or manufacture and sell goods in other countries with weaker currencies. Among companies in the Standard & Poor’s 500 stock index, more than 40% of revenue comes from outside the US, which can cut into earnings when foreign currencies are translated into dollars and can make US products less competitive. Among the companies that become less attractive…
US multinational corporations that derive much of their revenue from sales in foreign countries. They book slimmer profits as they translate revenue in weaker foreign currencies into US dollars. Examples: Avon Products (AVP), which derives 88% of revenues overseas…Colgate-Palmolive (CL), 80%…International Business Machines (IBM), 65%…Johnson & Johnson (JNJ), 53%…and McDonald’s (MCD), 69%.
Companies that benefit from foreign tourists. They will see a steep drop-off in revenue because the strong dollar makes it much more expensive to visit and spend money in the US, so fewer foreigners will book US vacations. Examples: Online travel websites Expedia (EXPE) and Priceline (PCLN)…and Tiffany & Co. (TIF).
Emerging-market stocks. The economies of many developing nations, such as South Africa, Brazil and Russia, depend heavily on exporting commodities. Since most commodities are priced in dollars, these countries get less money for their chief exports, which leads to slower economic growth.