The terms weak dollar and strong dollar are generalizations used in the foreign exchange market to describe the relative value and strength of the U.S. dollar against other currencies. The terms "strong," "weak," "strengthening" and "weakening" are interchangeable for any currency.
Defining a Strong and Weak U.S. Dollar
A strong dollar means that the U.S. dollar has risen to a level that is near historically high exchange rates for the other currency relative to the dollar. For example, the exchange rate between the U.S. and Canada has hovered between 0.7292 CAD/USD and 1.0252 CAD/USD, which means that if the current exchange rate is at 0.7400 CAD/USD, the American dollar would be considered weak and the Canadian dollar strong.
A strong U.S. dollar means that the currency is trading at a historically high level, such as 1.1000 CAD/USD. (For a real-world example, see "Trump Comments Trigger U.S. Dollar, Bond Yield Slide.")
The terms strengthening and weakening have the same context in that they each refer to the changes in the U.S. dollar over the period of time. A strengthening U.S. dollar means that it now buys more of the other currency than it did before. A weakening U.S. dollar is the opposite – the U.S. dollar has fallen in value compared to the other currency – resulting in fewer U.S dollars being exchanged for the stronger currency.
For example, USD/NGN (dollar to Nigeria's naira) is quoted at 315.30, which means that $1 USD = 315.30 NGN. If this quote drops to 310.87, the U.S. dollar would be said to have weakened compared to the Nigerian naira, since $1 USD translates to fewer naira than before.
Why a Strong Dollar Could Be Bad for Investors
The U.S. dollar hit its highest levels in 13 years shortly after Donald Trump won the presidential election in November 2016, as indicated in the above example. However, since his inauguration, the corresponding dollar index has lost around 9% versus a basket of other currencies. The dollar has experienced significant volatility as investors reacted to President Trump's proposed overhaul to current tax policy – and the expectation of higher interest rates amid the arrival of a new Federal Reserve chairman in the months ahead – with a great deal of skepticism and caution.
Even though market fluctuations could make you think otherwise, a strong U.S. dollar is not tied to a strong U.S. economy, as many pundits like to state. In fact, the U.S. economy is not as strong as the dollar, at least for the moment. Strength, as noted above, is relative to other currencies where valuations are being reduced in an effort to help fuel growth. In the case of interest rate increases by the Federal Reserve have leveled out at 1.5% at the moment. Additionally, we cannot discount deleveraging playing a role as debts are being paid off, leading to fewer dollars in the system and increasing the value of those dollars.
U.S. Dollar Impact on Multinational Companies
A strong U.S. dollar could be bad for large-cap multinationals because it makes American goods more expensive overseas. If the U.S. dollar continues to appreciate, then it could also have a negative long-term impact because those overseas consumers will begin to turn away from American brands.
The sectors impacted most by a strong dollar are technology, energy and basic materials, but the large-cap names that will potentially see their earnings take a hit go well beyond these three sectors. Some of the names that have been negatively impacted or might be negatively impacted by a strong U.S. dollar include:
- General Motors Co. (GM)
- 3M Company (MMM)
- Procter & Gamble Co. (PG)
- Estée Lauder Companies Inc. (EL)
- International Business Machines Corp. (IBM)
- Chevron Corp. (CVX)
- E. I. du Pont de Nemours and Co. (DD)
- United Technologies Corp. (UTX)
- Accenture plc (ACN)
- Oracle Corp. (ORCL)
Domestic Companies Not Impacted by U.S. Dollar
On the other end of the spectrum, domestic companies will not be negatively impacted by the U.S. dollar. However, while the domestic economy is often advertised as strong, this is primarily based on the labor market. The labor force participation rate, not just the unemployment number is often the best indicator of labor market strength. (For more, see "The True Unemployment Rate: U6 Versus U3.")
The truth is that the vast majority of stocks will have a relatively difficult time seeing appreciation over the next year due to a lack of wage growth and sustainable consumer spending. However, if you would like take a long-term stock selection approach without having to worry about a U.S. dollar impact, the following companies may be worth further analysis:
- Alaska Air Group, Inc. (ALK)
- Dollar General Corp. (DG)
- The TJX Companies, Inc. (TJX)
- CVS Health Corp. (CVS)
- The Allstate Corp. (ALL)
- UnitedHealth Group Inc. (UNH)
The Bottom Line
The strength or weakness of the U.S. dollar will impact FX traders and, in general, any international currency plays. On a stock selection level, a declining U.S. dollar means it may be prudent to consider staying away from multinationals and looking into companies that only have domestic exposure, as they are less impacted on a relative basis.
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