Strong U.S. Dollar: How Much of a Stock Market Threat?

U.S. Dollar StrengthImproving unemployment numbers added fuel to the rise in the U.S. dollar. While the U.S. dollar’s strength is likely to be a major issue this year, long-term investors shouldn’t worry.

Let me explain…

U.S. Dollar Gaining Strength

There is a glimmer of hope, as the U.S. dollar index (a measure of the U.S. dollar’s strength relative to a number of other currencies) hits multiyear highs. And that’s the fact that it’s something the stock market knows already; currency translation is a familiar issue when it comes to corporate earnings.

Of course, the recent unemployment report and how capital markets viewed it as a catalyst for the next rate increase really was about the headline number.

However, according to the U.S. Bureau of Labor Statistics’ Current Population Survey (the methodology of which changes over time and is used in the calculation of the headline unemployment rate), the U.S. labor force participation rate among civilians was at a record-low, at 62.8% in February 2015—the lowest level since before 1980. The total employment-to-population ratio is even lower at 59.3%, with part-time workers representing almost 20% of the total.

So there’s much more to the headline numbers, as regular readers of Profit Confidential will already know. It’s especially evident in the divide between Main Street reality and Wall Street speculation.

But what about the strength in the U.S. dollar?

Strong U.S. Dollar a Concern for Companies?

The U.S. dollar is going to be a problem going forward, and it’s likely that large corporations will be employing some significant financial engineering to help mitigate the currency’s rise.

With the first interest rate hike, which Wall Street expects this year, the floodgates are open to a further increase in the cost of money, as we are coming from below-market rates as it is.

However, as mentioned, the equity market is fully aware of the currency translation issue fostered by the U.S. dollar strength forecast and has, so far, mostly brushed it off as the cost of doing business.

Last year, investor sentiment actually was positive on interest rate hikes. The marketplace had the view that the Fed would only be doing so if the U.S. economy could handle it. I believe that this sentiment remains, but that doesn’t mean that equities won’t be in for some short-term downside when (or if) rates go up this year.

How to Invest as U.S. Dollar Gains Strength

In terms of the U.S. dollar strength and stock markets, the best investment strategy, I’d say, is to pretty much stay the course for a portfolio that’s long. By any measure, rates are low enough that a few extra ticks higher would still constitute a low cost of capital.

Global investors have been making their bets, as evidenced by the stronger U.S. dollar. The U.S. equity market still boasts decent fundamentals. Monetary policy is accommodative and capital costs are low. Corporate balance sheets, especially among large-caps, are in good condition with a tremendous amount of cash on the books. (See “4Q14 Earnings Season Uneventful; Five Stocks to Consider for Steady Return.”) And the outlook for rising dividends and share repurchases remains solid, even with the expectation of rising interest rates. Simply put, factors are positive for the long-term.

A stronger U.S. dollar has its drawbacks, but it is a reflection of global investor sentiment. And as always, capital markets bet in advance of potential reality.