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Bucking the Trend: The US Dollar’s 13-Year High and Potential Impact

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November 30, 2016
USD Index Touches 13-year High
3D_generator/Getty Images

Since the tallying of the U.S. presidential election results, the financial markets have been on the move. In case you've been too busy shopping all the pre-holiday sales, here is a quick recap of the major market moves:

  1. The major U.S. stock indices soared to new all-time highs
  2. U.S. dollar index touched its highest level since March 2003
  3. U.S. 10-year Treasury yield climbed over 50 basis points to its highest level since July 2015
  4. Gold tumbled 15%, or nearly $200 an ounce, from its 2016 high

In other words, there has been a lot of action in a few short weeks. What might these new levels mean for you and your portfolio?

Stock, Dollar Moves

The stock market has been going up because participants “believe Donald Trump will pass legislation that will end up stimulating U.S. economic growth,” says Sam Stovall, chief investment strategist at CFRA. In turn, the anticipated pick-up in economic growth could lead to "a more aggressive Fed rate tightening schedule" Stovall says.

In turn, the U.S. dollar is rallying amid expectations of higher interest rates in the U.S. "The higher interest rates are attractive to foreign investors looking for higher yield. But, they need to first buy dollars in order to buy bonds," Stovall explains.

Pointing to the current strong rally phase in the U.S. stock market and the simultaneous gains in the U.S. dollar index, JJ Kinahan chief market strategist at TD Ameritrade says: "it is unusual."

What Does This Mean For Your Portfolio?

One question some investors may be asking right now is whether the dollar's strength could affect stock market returns. 

The concern among some stock investors is that the sharp rise in the dollar could weigh on revenues for large multi-national firms. "A rising dollar makes it difficult for multinationals to increase their sales when their goods are getting more expensive," Kinahan says.

The percentage of revenue affected is not chump change. A continued rise in the U.S. dollar could squeeze profit margins. "We estimate that 45% of the revenues for the S&P 500 from come overseas," Stovall says.

A rising dollar may also impact international investments. "It is a direct negative effect," Stovall says. "If I own an international mutual fund and the value of the dollar is up 3%, this will push my return down by 3%," Stovall explains.

Could It Be Time to Examine Potential Portfolio Shifts?

Kinahan points to the strong surge seen in the Russell 2000, which is a small-cap stock market index. "Many of the companies in this index are smaller firms with niche domestic businesses. Perhaps if we do go to a more protectionist stance there might be more opportunities for some of these firms," Kinahan says. Overall, mid and small cap companies tend to have less international exposure.

Think about portfolio protection using options. Kinahan says there are myriad strategies options traders might consider in order to help protect a portfolio, from a simple protective put to multi-leg options spreads.

Consider your sector exposure. Some sectors within the S&P 500 tend to have greater exposure to international sales than others. For example, consumer discretionary has less exposure to international markets than technology and energy, Stovall says.

TD Ameritrade clients can monitor the value of the U.S. dollar and other currencies and also trade directly from the Forex Trader page within the thinkorswim® platform. See Figure 1 below. 

International investments involve special risks, including currency fluctuations and political and economic instability.

Small-cap securities are subject to erratic market movements and may have lower trading volume than securities of larger established companies.

The protective put strategy provides only temporary protection from a decline in the price of the corresponding stock.  Should the long put position expire worthless, the entire cost of the put position would be lost.

Spreads and other multiple-leg option strategies can entail substantial transaction costs, including multiple commissions, which may impact any potential return.  

thinkorswim Forex Trader

FIGURE 1: LIVE FOREIGN EXCHANGE PRICES

Source: thinkorswim® by TD Ameritrade. In thinkorswim go to Trade > Forex Trader.  Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.

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