August 4, 2020
Chao Ma, Ph.D., CFA, FRM, Global Portfolio and Investment Strategist
Equity Sectors to Watch as the U.S. Dollar Weakens
Returns of equities and sectors in six dollar-weakening periods from January 1988 through June 2020
A rising U.S. budget deficit, an almost-doubled Federal Reserve balance sheet, and 25% more U.S. currency in circulation could continue to put downward pressure on the U.S. dollar relative to other major currencies. U.S. companies in the Information Technology and Materials sectors—with a significant share of sales from overseas—have seen their stock prices outperform when the dollar weakens. Conversely, sectors heavily focused on U.S. business—including Utilities and Consumer Discretionary—have lagged.
Considering the influence of a weakening dollar in isolation can be misleading. For example, Developed Market (ex-U.S.) and Emerging Market Equities have tended to outperform in dollar-weakening periods. Some of this was likely due to a more favorable international economic outlook and more preferential overseas investment opportunities—a trend that is less evident today.
What it may mean for investors
We favor a holistic investment approach that takes into consideration macroeconomic, valuation, and sentiment factors—along with currency movement—when exploring equity-market opportunities. We currently favor U.S. over international equities—along with higher-quality asset classes and sectors such as U.S. Large Cap Equities and Information Technology—to potentially capitalize on market leadership and to “hedge” against potential uncertainties in the evolving pandemic and the upcoming elections.
Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets.
Communication services companies are vulnerable to their products and services becoming outdated because of technological advancement and the innovation of competitors. Companies in the communication services sector may also be affected by rapid technology changes; pricing competition, large equipment upgrades, substantial capital requirements and government regulation and approval of products and services. In addition, companies within the industry may invest heavily in research and development which is not guaranteed to lead to successful implementation of the proposed product. Risks associated with the Consumer Discretionary sector include, among others, apparel price deflation due to low-cost entries, high inventory levels and pressure from e-commerce players; reduction in traditional advertising dollars, increasing household debt levels that could limit consumer appetite for discretionary purchases, declining consumer acceptance of new product introductions, and geopolitical uncertainty that could affect consumer sentiment. Consumer Staples industries can be significantly affected by competitive pricing particularly with respect to the growth of low-cost emerging market production, government regulation, the performance of the overall economy, interest rates, and consumer confidence. The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions. Investing in the Financial services companies will subject an investment to adverse economic or regulatory occurrences affecting the sector. Some of the risks associated with investment in the Health Care sector include competition on branded products, sales erosion due to cheaper alternatives, research and development risk, government regulations and government approval of products anticipated to enter the market. There is increased risk investing in the Industrials sector. The industries within the sector can be significantly affected by general market and economic conditions, competition, technological innovation, legislation and government regulations, among other things, all of which can significantly affect a portfolio’s performance. Materials industries can be significantly affected by the volatility of commodity prices, the exchange rate between foreign currency and the dollar, export/import concerns, worldwide competition, procurement and manufacturing and cost containment issues. Real estate investments have special risks, including possible illiquidity of the underlying properties, credit risk, interest rate fluctuations, and the impact of varied economic conditions. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market. Utilities are sensitive to changes in interest rates, and the securities within the sector can be volatile and may underperform in a slow economy.
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