How the Dow Overcame a Strong Dollar in 2013

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

The Dow Jones Industrials (DJINDICES: ^DJI  ) are on track to gain more than 3,400 points in 2013, up 50 points at 12:30 p.m. EST on the last day of the year. One of the most surprising things about the Dow's gain is that it came despite the negative effects of a strong U.S. dollar against many major world currencies. Let's take a look at the dollar's performance in 2013 and how it affected the Dow's components, especially McDonald's (NYSE: MCD  ) , Procter & Gamble (NYSE: PG  ) , and Nike (NYSE: NKE  ) .

^DXY Chart

Dollar index and currency ETF data by YCharts.

How the dollar did in 2013
The currency markets were a tale of two worlds in 2013. On one hand, the dollar soared against the Japanese yen, with Japan's prime minister implementing pro-growth economic policies that explicitly encouraged yen weakness in order to bolster exports. In addition, the U.S. dollar also posted strong gains against the Canadian and Australian currencies, as both economies rely heavily on natural resources and therefore suffered from steep drops in prices for many commodities. Currency ETFs tracking the foreign monetary units showed losses of nearly 18% for the yen, 12% for the Australian dollar, and 6% for the Canadian dollar.

In Europe, however, the euro and British pound both gained ground against the dollar, with currency ETFs tracking the two currencies rising 4% and 1.5%, respectively. Signs that the European economy could come out of recession raised hopes that the European Central Bank won't have to provide more economic stimulus, and that increased confidence in the euro. The United Kingdom has seen similar strength in its economy, leading currency traders to conclude that rising rates could come to the U.K. sooner rather than later, making the British pound look more attractive.

Add those two factors up and you get only a very small change in the U.S. Dollar Index during 2013. Because Europe is such an important part of the index, its modest gains were enough to largely offset the yen's more precipitous drop.

How the dollar affects the Dow
As much as the dollar's moves reflect U.S. economic strength, they also have a big impact on the multinational companies within the Dow. For instance, McDonald's gets far more of its sales from abroad than it does in the U.S., making currency impacts especially important. Europe is a particularly key market for McDonald's, and so gains in the euro during the second half of 2013 have helped the fast-food giant make more from its foreign revenue.

Similarly, Procter & Gamble has operations in 180 countries, making it especially dependent on foreign currencies. Despite having some pricing power, P&G is reluctant to hike costs for consumers in foreign markets every time the dollar rises, as it exposes the company to local competition and can create bad sentiment among customers. As a result, currency fluctuations can cause dramatic impacts on P&G's earnings, especially in emerging markets where devaluations are a constant threat.

Nike's brand is known around the world, making it a key staple in many countries. One problem for the athletic apparel maker, though, has been that it hasn't made its international operations as profitable as its key North American segment. With more than three-quarters of its operating profit having come from domestic operations, Nike would like to have more of a currency problem if it meant boosting profits from abroad.

More broadly, currency impacts were cited as important factors affecting earnings among many other Dow components during 2013. Yet growth potential outweighed the currency headwinds, allowing the Dow to rise even in the face of a relatively strong dollar.

Keep your eye on the dollar
Many analysts believe the dollar could stay strong in 2014, especially if the Federal Reserve's tapering of its quantitative easing program leads to further increases in bond yields. If that happens, watch the Dow's multinational companies to see whether currency impacts weigh on earnings. At least based on 2013's performance, though, the dollar by itself probably won't do much to pull the Dow down.

Despite the dollar's strength, stocks stormed out to huge gains across 2013, leaving investors on the sidelines burned. However, opportunistic investors can still find huge winners. The Motley Fool's chief investment officer has just hand-picked one such opportunity in our new report: "The Motley Fool's Top Stock for 2014." To find out which stock it is and read our in-depth report, simply click here. It's free!


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