How Does a Strong Dollar Impact Stock Investors?

Question: What impact does a strong dollar have on U.S.-based investors? What does it do to earnings? Should I consider trying to hedge away my currency risk?

Answer: A look at the Trade Weighted U.S. Dollar Index shows that it's at its highest level in more than 10 years. And during the past one-year period, the index, which measures the strength of the U.S. dollar relative to other world currencies, has increased 15%.

U.S. consumers may find that a stronger dollar gives them a little more spending power. For instance, the dollar goes further when purchasing foreign-made goods, and one may find that the greenback goes further when traveling abroad.

How Does a Strong U.S. Dollar Affect U.S. Companies' Earnings? It's a complicated relationship. A stronger U.S. dollar can be a mixed blessing for larger, multinational companies or even smaller companies who do business abroad. It's generally a headwind for U.S. companies that rely on exports to other countries because the currency-translation effects mean that products made and sold in the U.S. (and priced in U.S. dollars) are more expensive to a foreign buyer. During periods of relative strength for the greenback, export growth tends to slow. Conversely, imports, which are relatively cheaper when priced in a foreign currency that is valued lower than the U.S. dollar on a relative basis, tend to grow; this, then, benefits foreign producers who sell their products to U.S. consumers. Lower import prices can also be good for U.S. firms that are bringing in lots of finished materials.

However, it should be noted that there are myriad ways companies can offset this effect, for better or for worse. Companies can hedge their currency risk with financial instruments. They can also manage their business in ways to increase efficiency and sales. In addition, supply-and-demand forces can often offset the effects of currency altogether.

To illustrate, let's look at U.S. automakers.

Similarly, in GM's first quarter, foreign exchange cost the company $1.8 billion in revenue but only $300 million in EBIT (same thing as operating income). In the second quarter, exchange cost GM $2.2 billion of revenue but only about $200 million in EBIT, said Whiston.

Now, let's turn to a foreign producer of autos:

What Does This Mean for Stock Investors?

According to data from S&P,

(though S&P cautions that this number is subject to how accurate the companies' reporting of global sales is). But from this data, it's possible to see some trends; the sectors with the highest exposure to global sales are IT companies (such as

But, as discussed, it cuts both ways. While foreign sales may take a bite out of companies while the dollar is strong, currencies have tended to be mean-reverting over time, meaning that the dollar will likely weaken against other currencies at some point. When that happens is a bit of an open question, though; many forecasters see this as unlikely in the short term given that the Federal Reserve plans to raise rates at some point this year, while the ECB and the Bank of Japan have loosened monetary policy to try to offset low inflation.

So, to sum up, currency matters a great deal for U.S. investors given the degree of corporate earnings that comes from abroad. However, the actual impact is varied across industry, and there are lots of moving parts. And, in terms of each individual company, the underlying strength of the business--and not its short-term currency exposure--will win out over time. For that reason, it probably doesn't pay to be too tactical with a currency-hedging strategy in your portfolio. Particularly after the dollar has had such a strong run, maintaining a balanced currency exposure may make more sense going forward. As Morningstar head of global manager research Jeffrey Ptak recently wrote, a portfolio spread across multinational companies and issuers is going to naturally encompass the offsetting effects of multiple currencies (as those firms and issuers do business in a number of locales).

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