Dollar’s recent rally worth watching

Despite the Federal Reserve's best efforts, the U.S. dollar is gaining strength, and this is a not a trend that financial advisers can afford to ignore.

Although the U.S. Dollar Index was down 1.45% year-to-date through Sept. 28, it is showing signs of getting stronger as fears of global economic strife and political unrest spread. Between Sept. 1 and Sept. 28, the index was up nearly 5% and up 7.2% from its 52-week low of 72.83 on April 29.

“The dollar is and has been the prettiest girl at an ugly dance,” said Paul Schatz, president of Heritage Capital LLC, which manages $110 million in assets.

Despite rising debt levels and a credit rating downgrade in the United States, the dollar is up 10% from the low point it hit in March 2008, setting the stage for a “multiyear rally,” he said.

“Long-term, I see the dollar and euro trading equal,” compared with 135 euros to the dollar now, Mr. Schatz said.

“In the short term, on any pullbacks, you should buy the dollar,” he said.

The last time the dollar strengthened against most global currencies in this manner was during the second half of 2008. From July 21 through Nov. 28 that year, the dollar, as measured by the PowerShares DB U.S. Dollar Index exchange-traded fund (UUP), gained 21%, while the S&P 500 fell by 34%.

“The dollar is a safe haven, regardless of what S&P says, and the dollar has started to break out versus all other currencies,” said Matthew Claassen, president of Claassen Research, which conducts market analysis for hedge funds.

Although there is plenty of debate about the forces strengthening the dollar, there is little dispute over what it means for certain sectors and asset classes.

“A strong dollar always hurts exporters,” said Drew Edwards, vice president and portfolio manager at Advisory Research Inc., which manages $6.5 billion in assets.

With that in mind, megacap multinational companies such as Altria Group Inc. (MO) and International Business Machines Corp. (IBM), which generate lots of profits overseas, likely will see their margins narrow.

“The 30 stocks making up the Dow [Jones Industrial Average] now get more than half their revenues from abroad,” said Brian Gendreau, market strategist at Cetera Financial Group Inc. “I've always been a big proponent of global growers, because the kinds of companies that do a lot of business abroad tend to benefit from a weak dollar. Yet in times like these, when the dollar is stronger, those sectors that one would rely upon to take advantage of a weak dollar have not done well.”

The materials sector of the S&P 500, one of the more globally diversified categories of the index, was down 16.8% year-to-date through Last Tuesday. Meanwhile, the industrials sector was down 12.3%, and the energy sector was down 8.7%.

After a summer of relative volatility, the dollar began its most recent rally just over a month ago and through Tuesday had gained 6% since Aug. 29, as measured by the PowerShares DB U.S. Dollar Index. The index illustrates the performance of the dollar compared with the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.

The fact that commodity prices tend to move inversely to the dollar puts added pressure on energy and agriculture sectors. For example, energy giant Exxon Mobil Corp. (XOM) may run into problems because it is a multinational company that relies on exports and because the price of oil is falling. Crude oil has fallen about 15% since July and is down 26% since hitting a high for the year of $113.93 per barrel April 29.

The price of the company's stock closed at $72.91 a share Sept. 27, down 21% from a 52-week high of $88.23 on Feb. 23.

Conversely, smaller companies — particularly those that derive more of their revenue domestically or import more than they export — are likely to do well with a strengthening dollar.

Then there's Starbucks Corp. (SBUX). This company is positioned to benefit from the strengthening dollar because it imports most of the coffee it sells and it can now do so more cheaply. Shares of Starbucks reached a 52-week high of $42 on Sept. 20 and closed last Tuesday at $39.85.

IGNORING FUNDAMENTALS

Of course, there's always the risk that investors could ignore such fundamental distinctions of companies like Starbucks, and essentially throw the baby out with the bath water. That is exactly what happened when the dollar rallied in 2008 and Starbucks stock was pushed down to a five-year low of around $8, introducing an attractive value play.

While some advisers might be tempted to play a strong dollar through the currency markets, they face the quandary of what currency to pair with the dollar.

A better hedging option can be found in emerging-markets bond funds, according to Sam Jones, president of All Season Financial Advisors Inc., which manages $110 million.

“The best way to neutralize the price risk is to pair the dollar with some inversely correlated sector,” he said.

Over the first 26 days of September, for example, the dollar rallied 5% and the $4.5 billion Emerging Markets Bond Fund (PEBAX) from Pacific Investment Management Co. LLC declined by 5%.

Questions, observations, stock tips? E-mail Jeff Benjamin at [email protected]