Most Americans instinctively view a strong dollar as positive—and for good reason. A solid greenback means greater purchasing power abroad, cheaper imports at home, and a sense of national economic strength.
However, when it comes to the stock market, currency strength can be a double-edged sword, creating headwinds for companies with substantial international operations or those that sell mainly to overseas markets-potentially dampening overall market performance.
Key Takeaways
- Dollar strength reduces the value of foreign earnings for U.S. companies, potentially impacting corporate profits and stock valuations
- Multinational companies and exporters tend to face greater challenges during periods of dollar strength.
- Investors can adapt their portfolios with sectors that historically perform well during strong-dollar periods.
Why Is a Strong Dollar “Bad” for the Stock Market?
When the dollar strengthens, American products become more expensive for foreign buyers around the world, potentially reducing demand and market share abroad. This hurts exporters and domestic companies’ foreign operations. When those international revenues are converted back to USD, they translate into fewer dollars, directly impacting corporate earnings.
For example, if a company earns ¥10 billion in Japan, it will book $62.5 million in profits if the dollar is trading at 160 USD/JPY. But if the dollar strengthens to 170 USD/JPY it would yield just $58.8 million.
Large technology companies and industrial manufacturers, which can derive much of their revenue from overseas, are particularly vulnerable to dollar strength. This impact can cascade through the broader market, because these sectors represent a significant portion of major stock indices like the S&P 500.
What Investors Need to Know
In a strong-dollar environment, investors might consider increasing their allocation to companies with predominantly domestic revenue streams, as these businesses are naturally hedged against currency fluctuations. Smaller-cap stocks often fit this profile, as they typically have less international exposure than large-cap multinationals.
Sectors that have historically demonstrated resilience during periods of dollar strength include utilities, telecommunications, and real estate investment trusts (REITs), which generate most of their revenue domestically. Additionally, companies that benefit from lower import costs, such as retailers sourcing products from overseas, may outperform during these periods.
How to Hedge Against a Rising Dollar
Currency-hedged ETFs can help investors maintain international exposure while minimizing the impact of currency fluctuations. These instruments use financial derivatives to neutralize the effect of exchange rate movements on returns. Examples include the iShares Currency-Hedged MSCI EAFE ETF (HEFA), which provides broad exposure to developed market stocks while hedging against currency fluctuations, and the WisdomTree Japan Hedged Equity Fund (DXJ), which offers exposure to Japanese stocks while protecting against yen weakness relative to the dollar.
For investors looking to capitalize directly on dollar strength, the Invesco DB US Dollar Index Bullish Fund (UUP) tracks the dollar’s value against a basket of major currencies. When the dollar strengthens, UUP typically rises in value. However, it’s important to note that currency-focused ETFs like UUP can be more complex and have higher fees than traditional stock or bond funds. They’re often better suited as tactical positions rather than long-term core holdings in most portfolios.
Upsides of a Strong Dollar
While dollar strength can present challenges for investors, it also creates opportunities:
- Enhanced purchasing power for U.S. investors buying foreign assets.
- Potential bargains in international markets as foreign stocks become cheaper in dollar terms.
- Lower input costs for U.S. companies that import raw materials or components.
- Reduced inflation pressure as import prices decline.
The Bottom Line
While a strong dollar can be a drag on the stock market, informed investors can position their portfolios to weather and even benefit from these conditions. The key is to understand which sectors and companies are most vulnerable to currency strength and adjust allocations accordingly. Diversification across domestic-focused companies, currency-hedged international investments, and sectors that benefit from dollar strength can help create a more resilient portfolio. However, investors should remember that currency trends can reverse quickly, making it important to maintain a balanced, long-term approach rather than making dramatic portfolio shifts based solely on currency movements.