Where to Look for Opportunities amid Turbulence (Part 3 of 9)

(Continued from Part 2)

Part of the problem: The stronger U.S. dollar is negatively affecting earnings of U.S. large cap companies. This could change down the road, as benefits of cheaper energy catch up to offset that drag.

Market Realist – A stronger dollar hurts US large-cap companies.

The graph above shows the dollar index since the start of 2014. The dollar index indicates the strength or weakness of the US dollar (UUP) relative to other major currencies.

The index picked up in July 2014, and it has gained a whopping 21.6% since then. This year, the index has already gained 7.5%. However, the index dipped to 97.05 after touching 100 recently.

The massive gain is mainly due to the divergence in the policies of major central banks. The Fed wound down its bond-buying program in October 2014. Meanwhile, developed markets (EFA), including Europe and Japan, are seeing excess liquidity in the form of QE (quantitative easing). Also, the Fed could easily be the first major central bank to hike interest rates. This divergence has led to a strengthening of the dollar.

The US economy is relatively robust, especially in comparison to the economies of Europe (FEZ) and Japan (DXJ). This strength has led to an even stronger dollar. In fact, this is the main reason for the difference in central bank policies.

A stronger dollar, though, is a major headwind for export-oriented companies like Microsoft (MSFT) and Ford (F), as their products get expensive in economies like Europe and Japan, which have seen their respective currencies weaken against the dollar. Since small-cap stocks (IWM) focus more on domestic sales, their earnings should be less affected by the stronger dollar. However, a rising interest rate environment is a negative for small caps, as it will strain their already small cash flows.

Also, a stronger dollar affects your total returns on your international investments (ACWI).

Continue to Part 4

Browse this series on Market Realist:

  • Part 1 – Key Headwinds Have Led to Higher Volatility in US Stocks
  • Part 2 – What Led to the Underperformance of US Stocks?
  • Part 4 – Why US Consumption Isn’t Turning Around