The dollar has been weakening in recent months and currency strategists see more declines ahead. That could call for a different playbook for investors, including more foreign holdings.
In a note to clients on Monday, Goldman Sachs ’s currency strategists forecast a 5% weaker dollar in trade-weighted terms during the next year. The U.S. Dollar Inde x (ticker: DXY) has fallen almost 7% in the past three months. And while there have been past bouts of weakness in the dollar, such as in mid March, when the pandemic led to lockdowns, Goldman’s strategists see the latest decline as more fundamental.
The dollar had been roughly 20% overvalued before it began to decline in May, contributing to the slide. Gains in other currencies, such as the rise in the euro as Europe’s economic recovery from the pandemic has outpaced that in the U.S., also add to the case for a weaker dollar. Other factors include heavy Treasury issuance to fund the fiscal response to the pandemic, and other countries diversifying away from dollar assets, the Goldman strategists wrote.
For Société Générale macro strategist Kit Juckes, the test will come in August. If the dollar’s weakness persists next month, even when reduced trading volume tends to make markets move volatile, he would have to move forward his forecast for when a long-term decline—a move he has been expecting—might begin, he said in a note to clients.
What does a weaker dollar mean for investors?
A weaker dollar has typically been positive for earnings, with a 10% decline in the trade-weighted dollar increasing S&P 500 earnings per share by about 3%, according to Goldman’s David Kostin. It has also been positive for stock prices: Since the 1980s, the S&P 500 returned a median 2.6% in months with a sharp dollar move lower, versus 0.7% during months with a sharp rise in the dollar.
A cheaper currency also tends to bolster demand for U.S. stocks among foreign investors. As a result, Goldman expects foreign investors to buy $300 billion of U.S. stocks this year, meaning that they, rather than companies buying back their own shares, would be the largest acquirers of U.S. stocks.
But the biggest beneficiaries would be companies that get a larger share of sales abroad. In months where the trade-weighted dollar fell by at least 1.25%, international technology companies—a group that collectively gets 57% of revenue from abroad—and energy performed the best, according to Kostin. More domestically oriented discretionary stocks performed worst, the Goldman note said.
Goldman’s basket of companies with international sales above the median for their sectors include information technology companies like LAM Research (LRCX) and Nvidia (NVDA); energy companies such as TechnipFMC (FTI) and Baker Hughes (BKR); and Philip Morris International (PM), which makes all its sales abroad. Also positioned to benefit are some discretionary stocks, including Booker Holdings (BKNG), BorgWarner (BWA), and Las Vegas Sands (LVS), which make more than three-quarters of sales abroad.
A weakening dollar also makes non-U. S. stocks, in both emerging and developed markets, more attractive for dollar-based investors.
In a note to clients last week, Gavkeal Research’s Louis Gave wrote that “the dam is now starting to break for the dollar. And as it breaks, this has the potential to unleash a dramatically different investment environment than the one that prevailed in the past decade.”
A strong dollar has drawn capital from elsewhere, bolstering U.S. large-cap tech stocks, which in turn led to additional dollar buying, and posed a challenge for emerging markets. A weak dollar could unwind some of that and usher in a wave of growth among less developed economies.
In a note to clients, UBS Global Wealth Management strategist Xingchen Yu noted a rise in emerging-market stocks on the back of a faster-than-expected recovery led by China and a weaker dollar, as well as abundant liquidity globally. But although earnings appear to have bottomed out, setting up the potential for gains, the group has a Neutral allocation to emerging markets, reasoning that valuations appear stretched following a sharp rise over the past month.
The iShares MSCI Emerging Markets ETF (EEM) is up 6.7% since late June.
Still, Yu said, the extended weakness in the dollar should continue to bolster investors’ appetite for higher-yielding opportunities that have lagged behind in recent years. Emerging-market stocks are on the list.
By Reshma Kapadia