Strong dollar, weak stock market? Not necessarily. While there’s talk the current strength of the dollar could result in a headwind against commodities and stocks, there’s a possibility it can also work in the economy’s favor.
Let’s take a look at both scenarios.
Historically, S&P 500 returns have been mostly unaffected by the strength or weakness of the dollar. Stocks haven’t particularly suffered from a weak dollar or soared due to a strong one.
But there are certain industries and companies that could suffer if the dollar continues to gain substantial strength.
In relation to the currencies of our foreign trading partners, a strong dollar generally makes imported goods less expensive to domestic consumers, but more costly for foreign buyers.
While healthcare and utility companies have traditionally performed well in times of a strong dollar, energy and materials companies could experience a downturn. The reason is because their cost of doing business strongly relies on the price of commodities—which with a strong dollar—are more expensive.
Companies also have to worry about the strength of their sales abroad. As I previously stated, a stronger dollar makes American exports more expensive. This can cause consumers to flock to foreign companies offering lower-priced goods, thus lowering sales for U.S.-based companies.
Understandably, U.S. companies with the majority of their business based in North America are better equipped to handle a strong dollar than firms that are major exporters.
The major positive aspect to the strong dollar is that U.S. households obtain more purchasing abilities, with prices of imported goods falling.
Our economy is stronger than it has been in recent years in terms of employment and financial health. While we may still experience somewhat of a headwind due to the dollar as it reduces total effective demand, the benefits to consumers and our population as a whole will likely offset that negative.
Stocks also have the possibility of experiencing an upswing when the dollar is strong. According to research from Charles Schwab, the average annualized return for U.S. stocks when the dollar rises has been 12.8% since 1970. For bonds, it has been 8.5% in the years since 1976.
While there is a bright side to the strong dollar, we should also proceed with caution and keep a close eye on the way it affects the market. Come what may, we can only hope the current strength of our economy can help weather any headwinds that may come our way.