It is no longer news that the stock market has continued to rally since the election. Among many factors, expectation for changes in fiscal policy has helped the DJIA finally hit that elusive 20,000 milestone. But this is only the scaled average of 30 major stocks; the index is not broad enough to give an indication of the economy. Economic growth has been sluggish since the “Great Recession” of 2008, averaging around 2.1% based on GDP; average wages have remained flat and company earnings have been weak as of fiscal third quarter 2016. Some of these issues can be attributed to a strengthened dollar, which has appreciated against 6 major rivals by about 25% since 2014, according to FactSet.

Treasury secretary nominee Steven Mnuchin said that the strength of the dollar “has been tied to the strength of the US economy and the faith that investors have in doing business in America”. He did, however, also mention that an excessively strong dollar may have negative short-term implications on the economy. President Trump has stated that the US dollar may actually be too strong because “our companies can’t compete with Chinese Companies”. Anemic global economic conditions have encouraged foreign investment in the US because of its relative economic strength; the perceived safety and ability to achieve an acceptable rate of return on investments would in turn increase the demand for dollars. This strength is now in tandem with the proposed fiscal policies, which could cause further appreciation in the dollar this year—something many analysts agree on.

There are pros and cons to a strong dollar; it generally bodes well for American consumers to have a strong greenback. We get the most bang for our buck when traveling abroad, as goods and services in other countries become cheaper. That dream vacation to France would be much more affordable now than it would be a few years ago. Imports are cheaper, so those luxury cars from Germany will fall in dollar price. For US companies that import materials from other countries, they will see profit margins grow as a result of the lower cost of production.

But many US companies with international market exposure have had weaker profits over the last few quarters, citing the stronger dollar as a factor. Income earned from foreign sales decrease in value on their balance sheets. As the dollar strengthens against another currency, goods and services in the US become more expensive for people using that other currency; they might end up buying less of those American-made goods, which is ultimately bad for our domestic producers. Conversely, foreign imports become cheaper, making domestically produced goods become even more expensive abroad. Overtime, weaker demand for American goods and services creates a trade deficit, in which imports surge and exports plateau.

Essentially, a strong dollar is good for some and relatively bad for others. Economic theory suggests that currency fluctuations will eventually revert to an average level; cheap foreign goods will eventually see increased demand, raising their prices. Conversely, expensive domestic exports will both fall in demand and prices. Ultimately, equilibrium should be found. Time will only tell if this theory persists.

strong-dollar

Source: Bloomberg

An investor cannot invest directly in an index. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.

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