The U.S. dollar is on a tear following Trump's victory in the presidential election. The currency has been downbeat for the most part of this year, thanks to not-so-robust U.S. economic growth and low interest rates prevailing in the country.
Speculation over more fiscal stimulus, low taxes, an easier regulatory environment to be introduced by president Trump and further domestic job creation bolstered the inflationary outlook and took the greenback to a 13-year high lately. Even Fed chief Yellen strengthened the chances of a rate hike next month and sent the currency rallying.
Can the Rally Last?
The U.S. dollar reached an all-time high of 164.72 in February 1985 and a record low of 71.32 in April 2008. From that context, the dollar spot index (101.28 at the time of writing) is still trading at a 38.5% discount to the all-time high.
On November 13, Deutsche Bank predicted 5% more gains in the dollar through 2017. The bank believes that a strong U.S. dollar will leave a disinflationary impact to negate a possible reflationary fiscal policy "when the economy is already at full employment."
Citigroup is also of the same opinion. Note that Goldman Sachs Group predicted in September that the greenback will surge 15% based on expectations of a three-percentage point rate rise within the Fed tightening cycle through 2019.
The most expected beneficiaries are the funds following the U.S. dollar. The WisdomTree Bloomberg U.S. Dollar Bullish ETF (NYSEARCA:USDU) and the PowerShares DB USD Bull ETF (NYSEARCA:UUP) added about 4.8% and 4.5% in the last 10 days (as of November 18, 2016), respectively.
Supportive Technical Trend
Investors should also note that relative strength index of UUP was 47.37 on November 18, 2016, meaning that the fund is yet to reach overbought territory. The fund also has a positive weighted alpha of 4.10. A positive weighted alpha hints at more gains.
In such a backdrop, let's take a look at the ETF investing areas that will benefit and lose in a rising dollar environment.
U.S. Small-Cap Equities
As small-cap stocks are less exposed to foreign markets, these are less scathed by a stronger greenback. Plus, Trump's keen focus on revamping America, especially infrastructure-wise, and loose fiscal policies should set the stage for small-cap U.S. stocks. The iShares Russell 2000 ETF (NYSEARCA:IWM) moved about 13% higher in the last 10 days (as of November 18, 2016).
Play Japanese Equity or Short Yen
The policies of Japan and the U.S. dollar are now going in opposite directions, with the bank of Japan offering to purchase unlimited bonds for the first time under a refurbished policy agenda. On the other hand, the U.S. central bank is mulling over policy tightening. As a result, the U.S. dollar logged "its biggest two-week rally against the yen since 1988."
The CurrencyShares Japanese Yen Trust ETF (NYSEARCA:FXY) was off 7.1% in the last 10 days, while the WisdomTree Japan Hedged Equity ETF (NYSEARCA:DXJ) gained 9%. Investors should note that several Japanese companies are export-oriented and thus perform better in a falling yen environment. Investors can also play the ProShares UltraShort Yen ETF (NYSEARCA:YCS) to reap profits.
Bet on Europe Equites or Short Euro
Investors can also play the expected dollar surge by investing in the ProShares Short Euro ETF (NYSEARCA:EUFX) that gives inverse exposure to the daily performance of the U.S. dollar price of the euro. Ultra-easy monetary policy in the Eurozone led the CurrencyShares Euro Trust ETF (NYSEARCA:FXE) to lose about 5% in the last 10 days (as of November 18, 2016). The greenback has now established the "longest winning streak against the euro since the European currency's inception in 1999."
Investors should note that now U.S. consumers would find foreign goods and travel inexpensive. So, purchase of Japanese and European goods and services by U.S. consumers should get a boost. This economic trend can be tapped by investing in the iShares Currency Hedged MSCI EMU ETF (NYSEARCA:HEZU).
Emerging Markets' Currency in Trouble
Most emerging markets fell prey to the greenback's gains. Rising bond yields at home must have curbed demand for relatively high-yielding emerging market securities. As per the source, emerging market stocks and bonds have seen about $11 billion in foreign investments gushing out since election.
Be it Mexico, Brazil, Indonesia or Malaysia, most haven seen their currency weakening. To restore the slide, Mexico soon hiked rates to over a seven-year high to counter the plunge in the peso. Indian and Malaysian central banks are moving into foreign exchange markets to stabilize their respective currencies. The iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) was down about 3.7% in the last 10 days (as of November 18, 2016).
Gold Losing Glitter
Normally, commodities investing takes a hit on a rising greenback, as these are priced in that currency. Among these, safe haven and non-yielding asset gold was hit hard on renewed interests in risk-on investments. The SPDR Gold Trust ETF (NYSEARCA:GLD) was down over 7.4% in the last 10 days (as of November 18, 2016).