The U.S. dollar has maintained its strong rally so far this year, with a popular gauge of the strength of the greenback hovering near a two-year high. The strength is predominantly attributable to global central banks turning dovish and an array of weak European PMI manufacturing data. On the flip side, fresh bout of positive results from the U.S. economic calendar means the dollar will remain strong.
And let’s admit, as long as we’ve got Brexit, France’s yellow vest protests and an Italian recession, the U.S. economy surely will continue to remain alluring. So, how to play this dollar’s newfound strength? Small caps, being domestic-centric, are better positioned to weather a stronger U.S. dollar. This category of stocks should gain immensely as they are cushioned against the loss of competitiveness and currency translation impact of a stronger greenback. Needless to say, that multi-nationals are poised to lose their competitive edge, as foreign consumers will now see U.S. products as more pricey than non-U.S. goods.
What’s Driving the Dollar?
The ICE (NYSE:ICE) U.S. Dollar Index, which measures dollar’s strength against a basket of major currencies, traded at an intraday high at 98.322 on Apr 25, its highest reading since May 16, 2017. From Riksbank and the Bank of Canada turning dovish to lower-than-expected Australian first quarter CPI, all have been helping the greenback scale upward.
The Swedish krona recently took a beating against the dollar after its apex bank said that interest rates are likely to stay lower for longer than earlier anticipated. Dean Popplewell, vice president of Market Analysis at OANDA chipped in and said that “Sweden’s Riksbank tweaked its forward guidance so that the repo rate would remain at current level for somewhat longer period of time than was forecasted back in February — the next potential rate hike is near year-end or in early 2020.”
Elsewhere, the Canadian dollar and the Aussie dollar both fell against the greenback. Canada’s central bank did keep its rates unchanged as expected but trimmed its growth outlook for the first half of the ongoing year. In Australia, the Bureau of Statistics confirmed that consumer prices remained flat for the first quarter of this year, below analysts’ estimate of 0.2%. This weaker-than-expected reading on CPI is making investors’ believe that the central bank will cut interest rates later this year.
Things are also not-so-bright in the Eurozone. The euro continues its slide against the dollar, currently trading to its lowest level since June 2017. Germany’s Institute for Economic Research reported that the Ifo business climate index fell from a revised 99.7 points in March to 99.2 points in April.
However, the U.S. economy has gone from strength to strength in recent times. Headline durable goods orders expanded at 2.7% last month, easily surpassing estimates. In fact, durable goods orders grew at the fastest pace in seven months.
Similarly, core orders gained 0.4% compared to a month earlier. But, it was U.S. March retail sales’ surprise jump of 1.6% that primarily boosted the dollar up against its peers.
What Does a Stronger Dollar Mean for Stocks?
A rising dollar impedes earnings growth, which suggests that returns from the equity market might be subdued. Particularly, companies that derive a majority of their earnings from overseas will suffer. Such companies are exposed to foreign exchange risks between the United States and other countries they are operating in. Thus, if dollar gains strength, it tends to hamper foreign sales of such companies.
The tax cuts along with deregulation are further benefitting small caps, and helping their profits accelerate in the near term. One of the popular measures of small caps, the Russell 200 Index, has risen 16.8% so far this year, slightly more than the broader S&P 500’s rise of 16.7%.
5 Winning Picks
Small caps are set to benefit from wider domestic revenue exposure, which insulates them from the effects of a stronger dollar. Thus, investing in stocks with high domestic exposure in terms of revenue generation seems judicious. We have picked five such stocks that flaunt a Zacks Rank #1 (Strong Buy) or 2 (Buy).
Advanced Emissions Solutions, Inc. (NASDAQ:ADES) provides emission reduction technologies and specialty chemicals in the United States. The company has a Zacks Rank #1. In the last 60 days, one earnings estimate moved up, while none moved lower for the current year. The Zacks Consensus Estimate for earnings has moved 23.9% up in the same time frame. The stock’s expected earnings growth rate for the current year is 92.6% compared with the Zacks Investment Research
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Written By:
Zacks Investment Research