A Weak Dollar Can Be Investors’ Friend

There are attractive entry points now in stocks that stand to benefit from the trend

By Aaron Back

A weak dollar favors Coca-Cola, which derived 68% of revenue outside North America in its last fiscal year. / PHOTO: ARND WIEGMANN/REUTERS

The era of the strong dollar is likely over. For U.S.-based investors, that needn’t be a bad thing.

There are attractive entry points now in stocks that could benefit from the trend.

The U.S. dollar has been heading lower over the past several months as it has become clear that the coronavirus crisis is hitting the U.S. harder than many other advanced economies, and as the crisis has been met with unprecedented fiscal and monetary loosening. The WSJ Dollar Index is down around 9% since late March, and 6% lower since mid-May.

There are many reasons to expect further weakness. Chief among them is the Federal Reserve’s new policy framework unveiled last month. The Fed has pledged to let inflation run above its 2% target for an extended period to make up for past periods of weak inflation and not to respond to falling unemployment with pre-emptive rate increases.

This is a clear recipe for a weaker dollar over the long term. As TS Lombard macro strategist Oliver Brennan put it in a recent note, this framework would break the traditional relationship between America’s growth and foreign exchange: Investors will no longer respond to better U.S. economic news by bidding up the dollar in anticipation of Fed tightening.

But don’t despair. According to strategists at Goldman Sachs, periods of dollar weakness tend to see better equity performance. They calculate that since 1980, the S&P 500 has on average risen by 2.6% during months when the U.S. dollar has depreciated in trade-weighted terms by at least 1.25%, compared with gains of just 0.7% in months when the dollar has risen by that much.

A weak dollar mostly benefits companies with revenue overseas because it raises the value of those sales in dollar terms. U.S.-based companies that compete abroad with global rivals also can gain a competitive advantage because their relative cost base is lower.

Goldman calculates that, in months of sharp U.S. dollar weakness, sectors with high global exposure such as technology and energy have outperformed, rising on average by 3.3% and 2.6%, respectively. More domestically focused sectors such as consumer discretionary have done less well, rising 0.8% on average.

Individual stocks can vary widely within sectors. Since 1980, during months in which the dollar was weak, Goldman’s sector-neutral basket of stocks with high international sales has outperformed a basket with high domestic sales by 1.4 percentage points.

Within consumer staples, for instance, this means a weak dollar favors Coca-Cola, KO +0.32% which derived 68% of revenue outside North America in its last fiscal year, over PepsiCo, PEP -0.34% at 39%.

In sweets and snacking, Oreo maker Mondelez MDLZ -0.18% earned 73% of revenue outside North America, compared with 11% at the rather provincial Hershey. HSY 0.08% The global colossus of the sector is Colgate Palmolive, with 78% of sales outside North America, while Clorox CLX -0.07% is more domestic, with 84% of sales within the U.S.

Intriguingly, some of these more globally exposed stocks have underperformed recently, largely because they have benefited less from the U.S.’s great pantry-stocking wave of 2020. Coca-Cola is down around 9% so far this year, while Mondelez has performed similarly to the S&P 500, gaining around 4%. Colgate Palmolive is up around 11%, but that is far less than Clorox’s 40% surge.

There is no need for investors to rush into crowded trades such as gold or exotic dollar hedges like bitcoin. Opportunities abound to pick up quality U.S. companies that will benefit handsomely from a weakening dollar.

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