During the month of May the stock market has declined, while the U.S. dollar has strengthened. At first glance this might seem odd, as a stronger currency would normally be thought to be a sign of prosperity. Recent dollar strength has resulted from continued instability in Europe rather than an improvement in economic fundamentals in our country.
The situation in Europe is just a continuation of the Greek debt crisis that has been ongoing for the past two years. Greece has had in forming a new government and it is unclear if Greece will keep the Euro currency.
Markets do not like uncertainty. When perceptions of risk increase, investors tend to gravitate towards safer assets. Despite our own problems with deficits, the U.S. is considered to be a safer haven due to the size and liquidity of our currency.
From the perspective of a consumer, a stronger U.S. dollar is a positive—our imported goods cost less. The obvious example is the price of oil, which has dropped over the past month. This will eventually translate into lower gasoline prices.
Prices at the pump have been declining for most of the country, though California has been an exception again, because of temporary refinery outages. For a U.S. consumer who travels overseas, a stronger dollar is a positive, as someone is able to purchase more goods and services.
For businesses, a stronger dollar is more mixed. For a company that just operates in the U.S., such as a retailer, the business should be able to import goods at a lower price. However, for an exporter, our goods become relatively more expensive.
Countries that are experiencing recessionary conditions are likely importing less goods. Nearly 50 percent of earnings are garnered overseas for companies in the S&P 500, a stronger dollar becomes more of a negative.
In general, the best environment is when currency moves are fairly mild. A dollar that is too weak tends to be inflationary, while a dollar that is too strong is negative for manufacturing. The recent moves we have seen in the dollar have not been that large, and should not have a major disruption on our balance of trade.
An investor may wonder with all this uncertainty over Europe, if this is an appropriate time to be invested in the stock market. The best answer would be to determine the extent that earnings of U.S. companies will be impacted.
For now profits of American corporations have been strong, and many companies have been able to offset weakness in Europe with gains from other parts of the world. As long as the dollar does not change in a material manner from current levels, most U.S. companies should maintain their level of profitability.
The other concern would be if investing in international stock is still appropriate. If the U.S. dollar were to strengthen for a period of several years, then investing in international stocks would not be beneficial. However, currency moves are difficult to forecast—most international markets are trading at favorable valuations.
I still think having a portion of your money allocated to stocks in international markets is appropriate for the long term investor. Recognize that volatility will be higher until there is some further clarity on the situation in Greece, but selling during market corrections normally does not help one’s portfolio.
