What a Weakening Dollar Really Means for Investors

Question: I keep hearing that the dollar is weakening. What does that mean for investors? Will stocks decline, too?

Answer: The U.S. dollar has been on the decline this year. From a high of 0.96 at the start of 2017, the greenback fell to a low of 0.88 versus the euro on May 22. That's a slump of more than 8%. The Trade Weighted U.S. Dollar Index, which measures the strength of the U.S. dollar relative to other world currencies, has also slid 3.7% over the year. (Some perspective is needed, though: Both levels are high relative to those over the past 10 years.)

In an interview with The Wall Street Journal, President Donald Trump said, "[There are] some very good things about a strong dollar, but usually speaking the best thing about it is that it sounds good."

To Trump's point, a weakening dollar does sound bad. But is it?

The Impact on Households U.S. consumers may find that a weaker dollar gives them a little less spending power. Though he cautions that there are a lot factors that can throw rules of thumb out the window in the short run, director of economic analysis Bob Johnson says, as a general rule of thumb, a weaker dollar means more inflation.

"We import a lot of stuff that we buy in stores, so a weak dollar should generally make goods more expensive. The strong dollar of the past several years has had the opposite effect, pushing the prices of a lot of goods down sharply, especially clothes and electronics."

But a weaker dollar is not an unmitigated negative for the economy.

"In general, a weak dollar should help boost U.S. economic growth," Johnson said. "A weaker dollar would generally make U.S. goods more competitive in foreign markets, potentially raising the U.S. production of those goods."

The Impact on U.S. Companies A weakening dollar is not all bad news for all U.S. companies, either. A weaker U.S. dollar can actually benefit larger, multinational firms or even smaller companies that do business abroad. It's generally a tailwind for U.S. companies that rely on exports to other countries because the currency-translation effects mean that products made and sold in the U.S. (and priced in U.S. dollars) are less expensive to a foreign buyer. Thus, exports tend to grow.

Let's look at

"Apple prices its iPhones in local currency and doesn't move its prices too often to reflect currency changes, so the sale of an iPhone in China has led to less revenue, in USD terms, for Apple over the past couple of years. And since most of its costs are priced in USD, Apple has taken a bit of a gross margin hit as well," he said.

Colello says Apple continues to do quite well, and iPhone prices continue to rise, meaning demand for the iPhone Plus and phones with more storage have more than offset these currency headwinds.

The Impact on the U.S. Stock Market There is actually very little correlation between the spot price performance of the U.S. dollar and the returns of the U.S. stock market; over a three-year period, the correlation coefficient between the U.S. dollar and the Morningstar US Market Index is negative 0.11. Over a five-year period, it's negative 0.30.

According to data from S&P, the percentage of foreign sales among S&P 500 companies was around 44% in 2015 (though S&P cautions that this number is subject to the accuracy of the companies' reporting of global sales). But from this data, it's possible to see some trends: The sectors with the highest exposure to global sales are energy and information technology. Sectors with low reliance on global sales are telecom and utilities, as well as financials, materials, and healthcare.

So, it cuts both ways. While foreign sales may boost companies while the dollar is weaker, domestic sales act as a hedge when the dollar is strong. Though currency matters for U.S. investors given the degree of corporate earnings that comes from abroad, the actual impact is varied across industry, and there are lots of moving parts. In terms of each individual company, the underlying strength of the business--and not its short-term currency exposure--will win out over time.

Don't Worry Too Much If you have a diversified portfolio that includes multinational corporations and international stock funds that have unhedged currency exposure (which is true of most foreign-stock funds), you likely don't need to worry about hedging your currency exposure to offset dollar weakness. Currencies tended to be mean-reverting over time, meaning the dollar will likely strengthen and weaken against other currencies at various points. In addition, the U.S. dollar is not likely to slide too far too fast, given that the Federal Reserve plans to raise rates possibly two more times this year, while the ECB and the Bank of Japan have loosened monetary policy to try to offset low inflation.

In short, the best course of action for most individual investors is probably to tune out short-term currency movements altogether, and stay focused on your long-term plan.