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Dollar weakness adds to appeal of overseas assets.
Ever since the Covid risk-off sell-off bottomed in late March, the dollar has been on a downward slide and is now trading at a 2-year low.
There are many factors behind the greenback’s decline: a Fed that’s holding U.S. rates at ultra-lows; a poor U.S. effort at “flattening the curve’’ relative to the rest of the developed world; a rising current account deficit; even concerns a Biden administration (if it wins) will raise taxes. Many observers believe the dollar could be heading into a prolonged bear market. History shows cycles of dollar weakness tend to last a decade or longer, as occurred from 1985 to 1995 and 2002 to 2011.
What are the implications for investors? Don’t just think globally, act globally. A weaker dollar historically has tended to favor international equities, particularly in the emerging markets. That’s because foreign earnings and share prices are priced higher after they are translated into dollars. We saw this in the 1980s and 2000s, with foreign stocks as represented by the MSCI EAFE and MSCI EM Indexes outperforming domestic stocks as represented by the S&P 500 during these periods. Because most are bought and sold in dollars, commodities also tend to benefit in a similar way as stocks when the dollar weakens.
Emerging-market (EM) countries in particular stand to get a 3-way lift from a weakening dollar: 1) the positive currency-translation effect to earnings; 2) lower debt costs—most issue dollar-denominated debt, meaning it takes less of their currency to service outstanding debt; and 3) stronger growth as the economies of many EM countries are commodity-based. Commodities act as a hedge against inflation and a falling dollar, as does gold (it’s also denominated in dollars, so when the dollar falls, its price rises).
To be sure, a weaker dollar helps some U.S. companies. Foreign sales account for more than 40% of total S&P sales, and while they’ve been clobbered as the Covid crisis has wiped out global demand, U.S. exporters get a competitive boost. A weaker dollar makes their products and services less expensive after currency translations.
Still, the weaker dollar story is a good one for overseas investors, particularly amid signs European and Asian economies may be emerging faster from the pandemic than here in the U.S. Even if that proves not to be the case, a weaker dollar is a tailwind that international investors may do well to ride.