Dollar Investing - In Stocks

Includes: DIA, SPY
by: Mike Steinhardt

I am not talking about currency investing.  I am talking about investing in a stock because of the value or direction of the dollar relative to other currencies.

Over the past several years, fund managers, stock research firms and the media have often suggested that you should invest in stocks based upon their percentage of international operations and try to play the currency effect.  Meanwhile, I said that the weak dollar is a stupid reason to invest in stocks and I still say it. The theory went that a high percentage of foreign operations means that the company would benefit during a weak dollar period.  Of course, this concept went a long way to try and generate buying for large cap stocks and specifically humongo multinationals that had underperformed for many of the previous 6 or 7 years.  Did I mention that many of the brainiacs pumping this idea to the masses were managing funds that were heavily loaded with multinational stocks that had been hurting their performance?

First off, currencies are an asset class on their own whose values are largely determined by complex domestic and global macroeconomic factors.  If you want to invest in the dollar I think you should consider investing in the dollar and not some proxy in equity form.  Note that I have consistently cautioned non-experts from trading currencies.

People are/were so hung up on this they almost give the impression that there is no better reason to buy stocks than a weak dollar. The idea that the multinationals benefit greatly because sales accelerate when our cheapass dollar makes their products more competitive and more appealing to international purchasers is not a new idea. Secondarily, the dollar exchange rate does increase the earnings due to currency translation effects. I get the theory.  Presumably, these effects would allow a stock to have improving fundamental valuation metrics and allow for higher stock prices.

So what’s the problem with me? There is a difference between theory and reality.  Equities and the decision making process for building and managing a portfolio are much too complicated to just blindly pick multinationals over stocks that are purely domestic.

When the broad statements about buying multinationals are mentioned, do you ever hear which specific currency pair they are discussing?  I never did.  I just heard the “weak dollar” as if they were referring to the US Dollar index which is a basket of currencies, not specific ones.  So what does “weak dollar” mean exactly?  Weak dollar relative to what?   What if it is the Canadian dollar and not the Euro or Yen or whatever.  Does it matter which currency pair?  Does it matter whether the company actually does business in a country with a currency that appreciated more dramatically than some other currency?  What percentage of total revenues and cash flows came from each currency?

If the general theory was accurate, then wouldn’t you expect that as the dollar was crumbling over the past 6 years that the multinational stocks would have done extremely well. HMMM!  The reality is that the stock prices of many multinationals declined dramatically and consistently from February 2002 when the US Dollar Index last peaked.

Since the beginning of February 2002 through today’s close, here are the performance figures of relevant indices.

  • US Dollar Index declined approximately 36%
  • S&P 500 Index increased 4.9%
  • Russell 1000 Index (large cap) increased 9.2%
  • Russell 2000 Index (small cap) increased 44.4%

Okay, so Russell’s small caps stocks as a group have done about 4 times better than Russell’s large caps.  So when does the payoff come in the form of higher stock prices for the large caps?  I thought that the fund managers and others promoting this concept were interested in stock performance.   Did they get higher revenue growth than small companies?  Some did.  Some did not.  Are we measured on whose sales go up faster or are we measured on whose stock prices go up farther and faster?  Were the multinationals more profitable in their international operations?  Most certainly were.  Are we measured on who has the most profits or better currency translations or are we measured on whose stock prices go up farther and faster?  I love sales growth, I love diversification in geographic sales, but if the stock prices don’t respond, it is not impressive.

While the large cap vs. small cap indices had clear disagreement with the weak dollar theory, not every stock worked out that way.  Certainly, some small stocks did worse than other small stocks from 2002 until now and some small stocks did worse than multinationals.  But that is always the case.  Each stock has its own issues.  The percentage of international revenues and earnings is just one variable and after looking at the data, I found no evidence that showed performance that was uniquely attributable to one percentage or the other of foreign operations.  For each stock that did well, I could find another that did poorly with roughly the same foreign component.  For each stock that did well, I could find another that did equally well without having foreign revenues.  Lastly, the same stock went up and down pretty significantly several times while the dollar weakened rather consistently during the same period.  If the dollar was such an important reason to invest, it should have been a reliable method…it was not.

For the record, now that some people have begun suggesting that the dollar has bottomed and is heading higher, I am hearing that investors should reverse the previous theory and buy small stocks that have a low percentage of foreign operations.  As you might imagine, I find this logic to be about as poor as the weak dollar argument.

I am not suggesting that multinationals are good or bad investment decisions or that small caps are good or bad decisions.  All I am saying is that the dollar’s weakness or strength and its direction is not a reliable indicator to help you pick stocks.