The currency game
The upside and the down
You have been hearing a lot more about the strength of the U.S. dollar relative to other currencies for some time. The U.S. dollar has risen 15 percent against the Euro in the past 12 months Today, a U.S. dollar is equivalent to .87 Euros and a Euro will buy 1.13 U.S. dollars. A few years ago, the Euro traded at E$ 1.58 and the dollar only bought .63 Euros. Other European currencies have also been hurt, including the Russian Ruble, which dropped 41 percent this year, making it one of the worst currencies in the world after the Hryvnia in Ukraine.
There are a few reasons for the dollar's rise. First, the U.S. economy appears to have the most momentum compared to other world economies and signs point to continued positive growth. GDP growth in the U.S. is 2.6 percent and the unemployment rate has dropped to 57 percent in January. In comparison, Europe is still on the verge of a recession and unemployment is well over 10 percent. U.S. interest rates, while low, also offer more yield than investors can find overseas. A reduction in the trade deficit because of the 50 percent correction in oil prices has also been a big factor.
While currency movements are garnering headlines, unless you're traveling outside the U.S., you probably wouldn't know where the Euro, Yen, or Ruble are trading at any given time. The truth is currency markets change all the time. For example, when the commodity markets are strong, the currencies in the countries that export a lot of commodities are also strong. It wasn't that long ago that the Canadian, Australian, and Brazilian currencies were expensive and today the reverse is true.
There are some benefits to having a strong dollar. A nation with a solid currency attracts more foreign capital. One of the main reasons the American stock and bond markets have been so strong since the financial crisis is simply because foreigners want to invest in the safest and most productive country and America has been just that.
Another upside to a stronger currency is that some companies with excess cash might be able to pick up assets in foreign markets and get more for their money. The Japanese did this in the 1980s when they were buying U.S. assets such as Pebble Beach or Hawaiian real estate.
Of course, there are also disadvantages to the dollar's increasing value. For large U.S. companies that derive any earnings from abroad, a strong U.S. dollar will hurt their bottom line. In the most recent quarter, many multi-national companies based in the U.S. have warned that their future earnings will be negatively impacted by a stronger currency. However, we view the strong U.S. dollar as a temporary setback to earnings. Once this piece of news is factored into stock prices, investors will discount the currency piece and look forward at the quality of earnings in terms of future sales and revenue growth.
Currency fluctuations are just one factor we examine when we analyze companies to include in our equity income model. Our research also includes evaluating earnings growth, dividend growth, profitability and a company's margin of safety. We look for companies that have low debt levels, strong credit ratings, diversified revenue sources and dividend payout ratios that are significant, but in line with industry peers. Taken as a whole, these metrics help us select stocks that have a high probability of delivering a meaningful and growing income stream regardless of what market fluctuations may be at work.