Most stock investors don't pay a lot of attention to the currency markets. But for more than a year, the U.S. dollar has been steadily losing value against most of its foreign counterparts, and the move has had plenty of ramifications -- not just for the foreign exchange markets, but for corporations around the world as well.
Now, though, it looks like the dollar's plunge may be coming to an end. That leads to an obvious question: If the dollar is poised to rise from here, how will it affect your investments?
What goes down must go up?
It's easy to understand why the dollar has been under pressure in recent years. Rock-bottom interest rates make the currency unattractive to fixed-income investors seeking substantial returns from their investments. High budget and trade deficits should theoretically lead to currency weakness over the long haul. And with the loss of the U.S. government's AAA credit rating, faith in the nation's ability to resolve its differences and get back on a sustainable financial track seems lower than ever.
But despite the negative attention that the dollar has gotten, the same arguments hold true for many other currencies, and that realization may be driving gains. In particular:
- The Swiss franc plunged after the Swiss National Bank made an amazing intervention in the foreign exchange markets, essentially pegging the franc to the euro and lopping off more than 10% of its value as a result.
- Increasing concerns that Greece will default soon have pushed the euro down, and because the euro is the biggest component of the widely followed Dollar Index, that index is finally showing signs of potentially reversing a months-long downtrend.
- Moves from emerging markets like Brazil to contain red-hot currency swings seem finally to be working, as the Brazilian currency has given up some of its past gains.
Of course, we've seen false alarms from past dollar up-moves that proved to be short-lived. But if this is the real deal, what's the best way to profit from a stronger dollar?
What euro investors are doing
One interesting answer comes from looking at what institutional investors outside the U.S. are doing. For instance, as Europe remains under pressure, you might expect European investors to run from the region entirely.
But instead, investors are focusing on companies that are best poised to survive euro turmoil and profit from its weakness. Export-oriented megacaps Royal Dutch Shell (NYSE: RDS-A) and Vodafone (Nasdaq: VOD), as well as drug companies Sanofi (NYSE: SNY) and GlaxoSmithKline (NYSE: GSK), are based in Europe, but they do much of their business both in the U.S. and throughout the rest of the world. As a result, they'd benefit from a stronger dollar against the euro. Similarly, British American Tobacco (AMEX: BTI) and Nestle are consumer favorites around the globe.
Even though these countries do plenty of business in Europe and therefore could suffer from economic turmoil in their home region, having an international presence helps buffer them from the full impact of the problems. However, U.S. investors have to understand that the benefits of a weaker currency for the bottom lines of these companies will have an offsetting negative effect on their returns in dollar terms if the value of the euro continues to fall.
Conversely, U.S. companies that do a strong business in Europe, such as Kraft Foods (NYSE: KFT) and Johnson & Johnson (NYSE: JNJ), could see weakness if the dollar continues to strengthen. Even if their foreign revenues stay stable in euro terms, they'd translate to fewer dollars, causing sales growth to slow.
Focusing on the long term
But the better perspective to have about the dollar is whether any advance is likely to be lasting. Following the end of the financial crisis, the dollar rebounded sharply, only to lose all its gains and then some. Anyone who expected a longer-term recovery for the dollar got hurt badly.
The fundamental problems that the U.S. is facing don't seem to be going away anytime soon. That suggests that any gain in the dollar might well simply be a good opportunity to load up on the investments that will eventually profit from a dollar decline.
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