It’s a really good time to own wads of crisp, green American cash.
As President Obama boasted during his State of the Union address last week, the U.S. economy is back. The job market is growing at a pace unseen in 15 years. The unemployment rate is lower than it was before the financial crisis hit. The Federal Reserve could – at last – raise interest rates from rock-bottom levels this year or the next. As the man said: “This is good news, people.”
And it has investors across the globe rushing to stash their money in the United States, giving the dollar more muscle. The greenback is up an average of 15 percent against other major currencies since July. Over that time, it’s gained 16 percent against the euro and 15 percent against the yen. And the trend is likely to continue as long as the U.S. economy looks like a rock star when compared with the rest of the world, investment advisers say.
For the average person, news of a stronger dollar might spark daydreams of a trip to Paris. But the implications of the dollar’s strength go far beyond what you might save on that imported bottle of chianti.
The stronger dollar, bolstered by robust economic growth, gives U.S. investors more reasons to keep their cash close to home. It eases worries about inflation and gives central bank officials more leeway on when to raise rates. But it also puts pressure on U.S. companies that get a high portion of their business from overseas.
“As much as we may have our problems in the United States, on a global basis, we’re still an island of stability and growth and confidence,” says Ed Keon, managing director and portfolio manager of Quantitative Management Associates, a subsidiary of Prudential Financial.
U.S. bonds are a powerful magnet.
To understand why the dollar is doing so well, consider the rest of the world. Europe is floundering. Japan is on the brink of yet another recession. Countries that rely on oil revenue – notably, Russia – are hurting as oil prices collapse.
Much of the foreign cash that’s driving up the dollar has been flowing into U.S. government bonds. Not that they’re making a killing: The increased demand sent bond yields lower last year despite the brighter economic news at home. But a 10-year U.S. Treasury paying close to 2 percent looks great when compared to Germany, where investors are settling for a 0.4 percent yield on 10-year bonds and negative yields on 5-year bonds.
And if the Fed does raise short-term rates this year, payouts on U.S. bonds could get a boost. Meanwhile, the European Central Bank introduced another round of bond-buying – to the tune of a trillion euros – on Thursday that could deflate the euro even further against the dollar.
American investors might be tempted to use their strong dollars to buy cheap stocks in countries with weaker economies. And they might very well find some good deals. But investment managers say the dollar’s climb up makes it a good time for U.S. investors to take a closer look at home.
The dollar’s gains could make stocks that are denominated in other currencies less valuable later even if the share prices don’t actually change, says Tobias Levkovich, an equity strategist for Citibank. Take someone buying European stocks today, he says: If the dollar keeps gaining against the euro, those shares would be worth less after the price is converted to dollars, even if the price of the stock in euros hasn’t changed.
“You can buy something cheap and unfortunately it can become cheaper,” Levkovich says. On the flip side, foreign investors buying stocks in the United States may find their shares are worth more in their own currencies if the dollar roars on.
As the dollar gains, some U.S. companies that import most of their materials from abroad may find that those supplies are now cheaper thanks to the currency changes, says Keith Lerner, chief market strategist for SunTrust Private Wealth Management. That could boost profit margins – unless they pass on those savings to customers, he says.
Take aluminum supplier Alcoa, which said the stronger dollar was a “major factor” behind its strong fourth-quarter earnings. The company saved in production costs because it mines much of its materials from Australia, Brazil and Jamaica, currencies that fell against the dollar. Yet it sells most of its products in the United States in dollars, so its sales weren’t as affected by currency swings.
For U.S. companies abroad, a fly in the ointment.
Still, the stronger dollar isn’t always good news for U.S. companies. Those that do a lot of their business abroad may find that the sales they make there are discounted once they are converted into dollars, Keon says. Those companies also have to work harder to keep foreign customers from straying to competitors that may undercut them with cheaper prices.
Johnson & Johnson, which recorded more than half of its total sales outside of the United States last year, reported that sales fell 0.6 percent in the fourth quarter, even as prescription sales increased. Vice President Dominic Caruso said during its earnings call that currency changes hurt sales and earnings “to a greater extent than we had anticipated.”
Investors and analysts will be watching Apple’s earnings report on Tuesday to see how much the dollar’s rise may be affecting the tech giant, which brings in more than 60 percent of its revenue from outside of the Americas, including more than 22 percent from Europe.
If the dollar climbs much higher, some companies may have to lower their prices to keep foreign customers from looking elsewhere for better deals, Keon says.
The United States already imports far more than it exports, Levkovich points out. So sales of certain goods that are shipped out of the country – think industrial companies that build powerful machinery and armaments with strong brands and few viable competitors – are not likely to fall off because of the stronger dollar, he says.
Another factor: Some foreign companies in more tenuous economies that may have borrowed in dollars to hedge against uncertainty in their own currencies may now be wishing they hadn’t. The rise of the dollar means they need to raise more money in their
own currencies just to keep up with debt payments, says Anthony Valeri, market strategist for LPL Financial.
“Emerging markets are cheap when you talk about valuations,” he says, “but they’re cheap for a reason.”
Some companies – in the United States and abroad – will be protected because they do hedge against currency changes, but the uncertainty over earnings is enough to encourage some investing pros to move more cash out of emerging markets and into U.S. stocks, Valeri says.
U.S. consumers come out on top.
The stronger dollar is giving companies at home and abroad more reason to battle it out over the American consumer. As the job market recovers, many consumers are now enjoying the first steady paycheck they’ve seen in years. And even though wages are essentially flat, some people are finding the dollars they have in their wallets can now buy a lot more than they did a year ago.
Companies overseas see the rising dollar as an opportunity to sell more products to Americans. Nissan has announced that it will produce more cars to sell here; Fiat Chrysler is planning to introduce a second car made in Italy to the United States – and it recently projected that 40 percent of its iconic Alfa Romeo sports cars will be sold stateside in 2018, compared with nearly zero in 2014, according to a report in the Wall Street Journal.
The strong dollar is also contributing, indirectly, to one of the biggest breaks given to U.S. consumers over the past year – cheaper gas prices. Oil prices are falling everywhere, but because the commodity is priced in dollars, American drivers are seeing a bigger discount than drivers in other countries.
So while U.S. drivers are raving about paying $2 gallon for gas, down from highs above $4 last summer, a gallon was going for about $6.60 in Italy earlier this month, down from more than $9 in the summer.
“For the U.S. consumer, it’s an unequivocal positive,” says Lerner, who called the drop in oil prices “a de facto wage increase.”
AAA analysts estimate that the gasoline price cut alone freed up more than $14 billion for American consumers in 2014, leaving them with more cash to spend on everything from shoes to movie tickets to washing machines. In a country where consumer spending drives about 70 percent of economic growth, that’s a big deal.
It bodes well for consumer discretionary stocks, which include retailers, movie theaters and other companies people turn to when they have free money to spend, says Valeri, of LPL Financial. Spending at restaurants and bars increased by 8 percent in December when compared to the year before, according to the Commerce Department. For Macy’s, J.C. Penney and Urban Outfitters, holiday sales grew by more than 2 percent from 2013.
American consumers who do make it to Europe or Japan or nearly anywhere else outside of the United States where the local currency has dropped against the dollar will find that their cash will go further. “A cup of coffee is going to cost you less,” says George Hobica, president of Airfarewatchdog.com. “Meals will cost less – train tickets, theater tickets.”
There’s a hitch: Talk of plummeting oil prices may raise hopes of finding bargains on flights. But that’s not happening. Flights are full and demand is still high, Hobica says. Airlines such as Delta that are already reaping savings from lower fuel costs are using that money to pay down debt and pad their bottom lines.
Even in the era of the strong dollar, high demand equals higher prices.