The U.S. dollar has kicked up a broader-market firestorm, climbing to fresh 12-year highs on Monday (figure 1). Global investors continue to pour funds into the U.S. dollar as divergences in the global economy widen. Plus, the dollar's daily uptrend got a boost from good news in the U.S. and, well, not so good news elsewhere.
Case in point: February jobs data released last week revealed a strengthening U.S. labor market as the unemployment rate fell to 5.5% and payrolls growth topped Wall Street estimates. Across the Atlantic, this week marks the start of the European Central Bank's quantitative easing, or bond-buying, program—its effort to battle back against deflation threats. And in Japan, Q4 gross domestic product data was revised down to show an annualized growth rate at 1.5% versus the previous estimate at 2.2%.
Adds Up to More Dollar Gains?
Investors around the globe who are staring at less-than-impressive domestic economic situations gravitate toward the U.S., where the Federal Reserve appears set to raise interest rates later this year. The U.S. is “the cleanest dirty shirt in the world," said Devin Ekberg, content manager at Investools®.
"For investors in Europe, there is too much volatility in the euro, and for investors in Japan, the yen is being debased at a pace we haven't seen before," Ekberg said. This drives foreign investors into U.S. dollar–denominated stocks and bonds.
Lots of media chatter and news stories have focused on how strength in the U.S. dollar may cut into profits for U.S. multinational companies. Think of consumer products, technology, and pharmaceutical companies that have a global footprint and bring home a portion of their revenues from sales abroad. Sure, dollar strength could dampen those totals, but "companies deal with this all the time and multinational companies do a fairly good job of hedging currency risk," Ekberg said.
Although some U.S.-based multinational companies may see pressure from the rising dollar, foreign inflows into U.S. investments likely aren't going away anytime soon, and that can provide a level of balance to the drag on U.S. exporters.
Be Choosy and Distinguish Short Term from Long Term
"U.S. stock investors should expect transitory volatility of multinational companies’ earnings due to the strong dollar, but it’s probably not a reason to sell everything. The strong dollar, and potential for higher interest rates, attracts a lot of foreign capital into our financial markets, buoying stock prices. If you accept the premise that a stronger dollar is a sign of an improving economy, these companies should also benefit from higher consumer demand," Ekberg says.
With this in mind, investors might consider further research into small-cap stocks that tend to limit their overseas business. As for large-cap issues, Ekberg says domestic-market companies like retailers, health care providers, and utilities can potentially be less vulnerable to a strong dollar’s sting.