Fisher Investments Canada: Don’t fear the strong dollar

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The strength of the U.S. dollar has fostered fearful headlines in 2022 after appreciating materially against most major currencies. Many fret the dollar’s rise may batter corporate earnings and signal more pain in equity markets. However, Fisher Investments Canada believes the strength of the dollar is largely irrelevant for equity markets. A strong dollar isn’t inherently good or bad – it is just one of many variables that affect the global economy. In this article, Fisher Investments Canada discusses the affects a strong dollar can have, and why we don’t believe dollar strength alone is a harbinger of more equity market weakness.

Why is the dollar so strong?

Unlike an appreciating asset like an equity – which represents ownership of a company and entitles investors to a share of the company’s current and future profits – currencies fluctuate solely on supply and demand relative to each other. The technicalities of what can cause supply and demand changes for currencies are highly complex – and wide-ranging, depending on the currency in question.

Fisher Investments Canada knows it’s difficult to precisely pinpoint the “real reason” a currency changes in value relative to another, but there are some commonly discussed theories for this year’s U.S. dollar strength. One commonly cited reason the U.S. dollar has risen this year is because of the United States’ aggressive approach to tightening monetary policy through rate hikes. The U.S.’s Federal Reserve has hiked rates at a quicker pace than other central banks, making U.S. debt more attractive relative to other sovereign debt. In turn, investors have needed to purchase dollars to buy dollar-denominated assets – creating more demand for the dollar and less demand for other currencies.

Another commonly cited reason for the dollar’s strength is because it is often seen as a “safe haven” in times of economic distress. Amid global recession fears, the U.S. economy is arguably in a better position than most other countries due to resilient consumption trends and relative energy independence – making it less susceptible to the energy crunch felt by others. This comparative strength can have a psychological and fundamental impact. Psychologically, investors may seek dollars for fear their own currency may weaken – creating a self-fulfilling prophecy in some ways. Fundamentally, it also gives the Federal Reserve more flexibility to raise interest rates higher than countries more susceptible to a weakening economy, which leads to increased demand for U.S. assets and U.S. dollars.

What are some consequences of a strong dollar?

Fisher Investments Canada believes currency fluctuations create winners and losers. For example, when the dollar is strong, a U.S. company selling its product in non-U.S. countries faces a choice. It can either keep local prices stable – hurting its profitability – or raise the price to compensate for a rising dollar –hurting demand. Simplistically, a strong dollar hurts U.S. exporters and helps U.S. importers. However, these decisions aren’t binary in the real world. Companies constantly adjust their pricing strategy over time and seek other ways to neutralize currency exposure.

For example, multinational companies operate in many different countries with a variety of currencies. They can control costs and manage currency fluctuations by shifting spending and their treasury operations. They can source raw materials and even labour globally. If a strong dollar makes a U.S. company’s product more expensive in other countries, it can preserve some of its profitability by deciding to increase imports from countries with weaker currencies, potentially lowering costs in the process. While every business has a different level of flexibility, many large companies also hedge for currency swings, which can limit the impact of sharp currency moves.

However, it is true that not all of the impacts of a strong dollar can be perfectly hedged away. In some cases, it can even contribute to higher levels of inflation in non-dollar denominated countries. Perhaps the most acute example relates to energy costs – oil, in particular. The global oil market is priced mostly in dollars. Countries reliant on energy imports, such as Japan and much of Europe, are adversely affected when a strong dollar raises energy costs and they have few alternative options to mitigate the impact.

Are we on the verge of a currency crisis?

Some investors fear a strong dollar poses a particular challenge for emerging markets, fearful of another Asian currency crisis like we saw in the late 90s. However, Fisher Investments Canada believes these fears are likely misguided. Then, many Asian nations’ currencies were pegged to the dollar. They borrowed heavily in dollar-denominated debt to finance booming economic growth, but kept little in currency reserves to fend off speculators. When their currencies came under pressure, they quickly ran out of firepower to defend dollar pegs and were forced to devalue. This caused debt levels and service costs to skyrocket in local currency terms – and crisis ensued. Today, these dollar pegs are largely gone and foreign exchange reserves are much healthier than in 1997.

Does a strong dollar threaten equity returns?

Equity markets are relatively efficient discounters of widely known information and quickly assess any impacts that currency movements may cause. Additionally, Fisher Investments Canada’s research has shown no clear correlation between a strong dollar and how equities perform.

Exhibit 1 shows the number of years the U.S. dollar and S&P 500 equity returns are up or down, from 1971 through 2021.* As shown, there is no consistent pattern between the direction of the dollar and U.S. equity performance. U.S. equities have been up approximately 80 per cent of calendar years, yet the dollar has been up just 55% of the time. U.S. equities and the dollar rose in unison in 45 per cent of those years, while stocks rose when the dollar fell in 35 per cent of those years. In years where U.S. equities were down, the dollar was up or down an equal number of times.

Exhibit 1. U.S. Equities versus the dollar

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Some may argue a strong dollar has less of an effect on the US economy, so looking at US returns man not accurately capture the true market impact of the dollar’s swings. However, as Exhibit 2 shows, US dollar fluctuations don’t noticeably affect the direction of global equities either. During years where global equities were up, it was just as likely the dollar would be up as it would be down.

Exhibit 2. Global equities versus the dollar

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Currency fluctuations shouldn’t drive your investment strategy

Fisher Investments Canada thinks investors shouldn’t let currency fluctuations influence their investment strategy. Instead of using the relative strength of the dollar to predict market decisions, investors may be best served by focusing on crafting a diversified, global strategy to mitigate the effects of currency fluctuations. A strong dollar may create winners and losers across the globe, but in our view, the strong dollar itself doesn’t automatically portend poor equity returns as some may fear.

*(Note that Fisher Investments uses the trade-weighted dollar to show the strength of the U.S. dollar compared to our common trading partners. We do this because the dollar’s strength relative to currencies of nations we have minimal trade with is not as relevant for this exercise.)

Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates. This document constitutes the general views of Fisher Investments Canada and should not be regarded as personalised investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments Canada will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.

Fisher Investments Management, LLC does business under this name in Ontario and Newfoundland & Labrador. In all other provinces, Fisher Asset Management, LLC does business as Fisher Investments Canada and as Fisher Investments.

This content was produced by Fisher Investments Canada. The Globe and Mail was not involved in its creation.