What does a weak US dollar imply for our economy and how should investors position themselves? Weak is a relative term when it comes to the economy. Reading the tea leaves can provide some insight about what to expect in the near term and how investors need to respond.
Setting aside political views about whether it is a good or bad thing to have a “weak” currency, let’s take a look at what’s been happening.
Dollar Fundamentals
The chart below shows the recent value of the dollar through October 4, 2013. Values for a currency or any other asset are driven by supply and demand as well as perceptions based on the emotional views of market players. In this case, the red line shows the noticeable downward trend of the dollar relative to other currencies since about 2002. This has coincided with the bursting of the Internet Bubble in 2000 and then followed by the rapid increase of US government debt beginning in 2002 when tax cuts were coupled with the costs of two wars and a new prescription drug benefit. This increase in federal deficit spending continued as classic Keynesian economic policies were used to help get the US economy out of the ditch caused by the Great Recession.
During this period, the supply of dollars has been growing as the Federal Reserve has pumped more and more dollars into the economy in response to the financial meltdown of 2008. And with no other fiscal policy from Washington, the Fed continues its “quantitative easing” to help bolster the economy. More dollars sloshing around with no increase in demand translates to less relative value.
Safe Harbor from the Storms
Over the past thirteen years, the financial markets have been hit with a number of crises: Dot Com Bubble, Flash Crash, Great Recession, Euro Crises among the PIIGS (Portugal, Italy, Ireland, Greece and Spain).
Almost every country has seen its sovereign debt explode most noticeably because of the Great Recession. Many of these European governments have had to increase borrowing to help keep their economies rolling or to dig each other out. Germany has been the financier of its weaker European cousins.
The US Dollar has been a “reserve” currency – the place that others park their cash. Despite the fact that we’ve had our own share of troubles, the US has been the ‘go-to’ currency when there has been the slightest whiff of turmoil. This ‘safe haven’ status is what was at risk when we came close to not having a debt ceiling deal and rating companies placed the US on a ‘watch’ list.
There have been periods where it has been climbing back but in general the dollar’s value has been trading in a pattern bounded by the two blue lines. Technical analysts call this a “consolidation” pattern.
So despite the fact that we have our own weakness as an economy and dysfunction as a government, we have been better relative to the alternatives resulting in an index value that bounces along between 80 and 85 for all of 2013. One possible reason for this trading pattern may be the fact that foreign governments continue to buy US Treasuries as a way to help stanch the slide in the dollar’s value which hurts the sales of their exports to the US.
Bear Market Indicator for the Dollar
Right now, there are few alternatives to our safe haven currency status and with continued weakness in other economies, it is unlikely that others will slow their purchase of dollars which could put further pressure on their export sales in a weak consumer market.
But eventually this too shall pass. And new patterns emerge. Since 2010 the Relative Strength Index (RSI) has been stuck below 60 and the current dollar value is below its 200-period moving average, both bearish indicators to many analysts. This means that it is likely that the dollar’s value will test the lower boundaries of that blue line and continue a new downward trend.
As there is a high correlation of the dollar’s values to the equities markets, this means that there may be a corresponding impact on US stocks. When these trends are discernible, it makes sense to position your portfolio to take defensive actions.
Opportunity or Danger for Investors
The Chinese character for danger and opportunity are one in the same. Whether one sees a ‘weak’ dollar as a threat or a way toward profit depends on your point of view and actions taken.
While a weak US currency makes imported goods more expensive and adds to the potential for inflation (BAD), it does make US goods and services that are exported less costly and theoretically more in demand overseas (GOOD). But since we do have a significant trade deficit, the positive impact of this weaker dollar may be cancelled by our reliance on imported goods (Thank you to Wal Mart, Apple and China … among others).
Weak US Dollar Impact for Investors
Here are some things to consider when developing a portfolio strategy:
- Consider investing in companies that have significant overseas sales operations that can take advantage of the currency valuation differences. Most companies in the S&P 500 Index have significant and growing revenues from overseas. A good option here is an Exchange Traded Fund like Vanguard S&P 500 (Ticker: VOO).
- Look at domestic manufacturers that may become more competitive. The falling dollar is not going to bring back the industrial economy, but it may push some marginally profitable companies into the black again. We’re seeing more manufacturers bringing operations back to the US to take advantage of this currency trend among other reasons.
- If you are holding a handful of low-interest bonds, come up with a game plan that envisions rising interest rates. How are you going to adjust? Consider investments in bonds and other assets that have interest rates tied to changes in the market and inflation. Generally, anything that has the ability to reset or pass through such interest rate or inflation costs will help insulate your portfolio from the impact of rising rates. This is where Floating-Rate notes may make sense as well as keeping your total bond portfolio duration on the short side (less than 3) to avoid large impacts caused by climbing interest rates. Consider Short-term Bond ETFs for this. Other areas that I use in building a MarketFlex portfolio include stocks with a history of growing dividends and Master Limited Partnerships.
- If you are really concerned about the future of the economy and the market, look to gold. Gold has historically been the refuge during time of economic upheaval, but it’s a lousy investment. Only a small part of your holdings should be in gold (less than 10% and probably closer to 5%).
- Hedge your stock market exposure. Low volatility stock ETFs have a value-tilt and these have been found to be less correlated to the market in general and offer some protection on the downside. Here you may consider adding iShares MSCI USA Minimum Volatility (Ticker: USMV), PowerShares S&P 500 Low Volatility (Ticker: SPLV) and PowerShares S&P 500 Buy Write covered call strategy (Ticker: PBP).
- Consider adopting a trading system that provides a tactical overlay to a traditional strategic asset allocation. Buy-and-hold can work in the long-run but if you’re retired or retiring, you have very little time to climb back to even. A tactical overlay for a portion of your portfolio which includes signals of when to buy or exit to cash may help avoid large losses.
