One of the biggest storylines in the investing world over the past year has been the plunge in the value of the euro against the U.S. dollar. A year ago, a euro would buy you more than $1.35 in U.S. currency, but the European currency will now only get you about $1.05. Many expect the value of the dollar to match or even surpass the euro in the near future for the first time since 2002. While that might seem like big news for currency traders, the effect on the stock and bond markets could be even more dramatic.
Why the dollar is important
At first glance, it might seem that stock and bond investors wouldn't see much impact from dollar strength. With the soaring U.S. economy, domestically focused companies have benefited greatly, with their share prices generally rising.
The problem, though, is that many U.S. companies do much of their business abroad. For multinationals, having to translate foreign revenue and profits back into U.S. dollar terms has been a huge weight on growth over the past couple quarters, as local competition in foreign markets has prevented those companies from passing the full amount of the currency effect on to their customers. Earlier today, Johnson & Johnson (NYSE:JNJ) was the latest to report a sizable dollar drain on growth, with the strong greenback turning what would have been gains in revenue based on operational results into a year-over-year decline.
U.S. stocks also suffer because of stronger competition in their domestic markets. For rivals in Europe, Japan, and elsewhere around the world, a strong dollar means greater profit opportunities are available in the U.S., and any profits they earn translate into a larger amount of euros or yen on their income statements. That phenomenon has played a major role in the positive performance in foreign stock markets so far in 2015, and it could continue to send export-driven companies' share prices higher if the trend persists. That could make it smart to focus on international stock opportunities for the foreseeable future.
Looking for income
In the bond markets, the effect of foreign currency movements has been even clearer. In Europe, negative interest rates have sent savers fleeing anywhere they can get a positive return on their money, and that has helped to fuel the rise in the U.S. dollar. Even with 10-year Treasury yields below 2%, foreign investors can get a lot more money than they can with near-zero rates on German and Japanese bonds. The dollar's rise has also given those foreign investors even larger gains in their local currencies once those bonds mature and are exchanged back into euros or yen. For U.S. investors, meanwhile, support from foreign buying could keep rates low and add to capital gains from bond investments.
Not everyone is certain the dollar will climb that last nickel's worth to equal value with the euro, as the Federal Reserve has been much less aggressive about raising interest rates than many currency traders expected. Nevertheless, unless the dollar starts weakening sharply in the near future, stock and bond markets will feel the effects from the foreign-exchange arena throughout the rest of 2015 and potentially beyond. Smart investors will keep paying attention to take maximum advantage of those conditions as long as they last.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.