Wednesday, April 29, 2009

Strong Dollar is a Double-Edged Sword

One of the big worries within the financial community is that foreign investors, particularly China, might begin selling some of their large holdings of U.S. Treasury securities, potentially creating a nasty decline in the U.S. dollar. However, a look at the dollar’s chart (below) reveals that it’s been rising since last summer. There are many reasons attributed to the recent strength in the dollar: its role as the world’s reserve currency at a time of global deleveraging; investors who were “short” the dollar are now buying it back to close their positions; the U.S. economy may recover quicker than Europe thanks to much larger fiscal and monetary stimulus efforts, etc.

Forgetting for a minute why the dollar has shown such resilience, maybe I should just focus on the fact that a strong dollar has got to be great news for dollar-denominated securities, right? Well actually it hasn’t been great news for many of the multinational companies that have large offshore operations, because they’re more vulnerable to large swings in reported revenue and earnings if there are sharp movements in currency markets. A great example of this is Pfizer, which yesterday reported disappointing earnings and highlighted a $640 million loss of revenue due to adverse currency exchange movements. (Pfizer is 8.7% of the Health Care ETF owned in Pinnacle portfolios.)

When analyzing currency fluctuations in context of our portfolios we’re always torn by the double-edged sword that a rising or falling dollar creates on current and future portfolio performance. On one hand portfolio securities are affected by the real time total return gains or losses from a rising or falling dollar (including the Health Care ETF). But on the other hand future gains or losses may be offset or trumped by the dollar’s impact on earnings for the companies that are held inside of those securities.

The investment world has many quirks, oddities, and vagaries that will test the patience and intellect of even the most seasoned and even-keeled investors. So if it sounds confusing or perplexing that recent strength in the U.S. dollar can be both good and bad for dollar-denominated investments at the same time, I guess that should be considered par for the course!

Trade-weighted dollar with 50 (pink) and 200 day (blue) moving averages (Source: Bloomberg)