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Chart of the Week

Weekly chart using economic data to address timely market topics from the Wells Fargo Investment Institute Global Investment Strategy team.

August 4, 2020

Chao Ma, Ph.D., CFA, FRM, Global Portfolio and Investment Strategist

Equity Sectors to Watch as the U.S. Dollar Weakens

Equity Sectors to Watch as the U.S. Dollar WeakensSources: Wells Fargo Investment Institute, © Morningstar. All Rights Reserved (i), July 21, 2020. Dollar weakening periods included October 1989 - February 1991, February 1994 - April 1995, March 2002 - January 2004, December 2005 - March 2008, April 2009 - July 2011, and November 2016 - February 2018. Real Estate returns started in November 2001. Indices used: for U.S. equities (and sectors), the S&P 500 Index; for Developed Market (ex-U.S.) Equities, the MSCI EAFE Index; for Emerging Market Equities, the MSCI Emerging Markets Index; for cyclical stocks, the MSCI USA Cyclical Index; for defensive stocks, the MSCI USA Defensive Index. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results. This chart was excerpted from the Investment Strategy report dated July 27, 2020.

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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.

Risk Considerations

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.

Definitions

MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.

MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.

MSCI USA Cyclical Sectors Index is based on the MSCI USA Index and captures large and mid-cap segments of the US market. The index is designed to reflect the performance of the opportunity set of global cyclical companies across various GICS® sectors. All constituent securities from Consumer Discretionary, Communication Services, Financials, Industrials, Information Technology and Materials are included in the index.

MSCI USA Defensive Sectors Index is based on MSCI USA Index and captures large and mid-cap segments of the US market. The index is designed to reflect the performance of the opportunity set of global defensive companies across various GICS® sectors. All constituent securities from Consumer Staples, Energy, Healthcare and Utilities are included in the index.

MSCI USA Index is designed to measure the performance of the large and mid cap segments of the US market. With 616 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the US.

MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.

S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the US stock market.

An index is unmanaged and not available for direct investment.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

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