By Joachim Klement
The dollar is stretched, but investing in U.S. importers can help you benefit from a strong dollar without being too exposed to inflation spikes or interest rate surprises.
The dollar has been very strong this year. This isn't a surprise. After all, it currently gets support from three factors.
First, there is the economy which remains much stronger than Europe or Asia. The strong economy, on the other hand, means that inflation is stickier than expected, which forced the Fed, and the market, to have a proper re-think of the outlook for interest rates. At the start of the year, we were discussing if the Fed would cut interest rates six or seven times this year. Today, we are discussing if the Fed will cut twice (as most people expect) or not at all. Indeed, there is even speculation the Fed might be forced to hike rates again.
On top of that there is increased geopolitical uncertainty due to the events in the Middle East. And every time there is uncertainty, investors like to hold dollars.
In the short term, the dollar looks stretched to me and I probably wouldn't buy it at these levels. But I think it will get additional support once central banks in Europe start cutting interest rates because this increases the interest rate advantage of the U.S. vs. the eurozone and the U.K., which makes the dollar even more attractive for investors.
However, many a good forecaster has been fooled by currency markets, so instead of investing in currencies I am thinking about investing in the stocks of major importers. A strong dollar is bad for exporters, but it is good news for importers. They can sell their goods earning dollars while paying their suppliers in euro, renminbi, pesos, or whatever currency they use.
Normally, this is a simple game. You just go for major importers like Walmart (WMT) and that's it. But the geopolitical risks and the Fed are complicating things. If the situation in the Middle East or in Russia escalates, oil prices may spike, creating a massive cost spike for many importers. And if the Fed decides to change its rate outlook and even starts hiking rates again, that would be bad for most companies.
So, I screened for companies that did two things at the same time. On the one hand, their share prices should rally when the dollar strengthens. On the other hand, their share prices should not be influenced too much by surprise inflation or surprise changes in Fed policy.
Two companies stood out to me.
First, there is Hubbell (HUBB), which manufactures and sells electrical devices from light fixtures and connectors to parts for electric substations and transformers. While 92% of its revenue is generated in the U.S., it has suppliers not only in China and Mexico but also in the U.K., Spain, and Brazil. Hence, if the dollar strengthens, profit margins are likely to increase and thanks to a business underpinned by the current infrastructure spending in the U.S., revenue will likely be solid no matter what the Fed or the economy does.
Then there is Monster Beverages (MNST). The maker of the eponymous energy drink generates 'only' 65% of its revenues in the U.S., but its costs are heavily geared toward imported products. Whether it is the aluminum for its cans, the ingredients for its drinks or the packaging, supplies are sourced from Mexico, China, Europe, and, of course, the U.S.
A strong dollar will increase profit margins for the company as it has in the past, but the 35% revenues made outside the U.S. (mostly in Europe) provides a little bit of a buffer, should the dollar unexpectedly weaken. Meanwhile, the shares have been uncorrelated to changes in inflation or interest rates in the past, because consumers keep gulping energy drinks no matter whether they have to pay more for gas or their mortgage -- probably because many of the company's customers are too young to have a mortgage in the first place. At least in the past episode of high inflation and high interest rates, the company's demand hardly budged. And in the current environment, with all the uncertainty around inflation, politics, and interest rates, that is a good thing.
Joachim Klement is head of strategy at Liberum, a London-based investment bank. He is author of "7 Mistakes every Investor Makes" and "Geo-Economics: The Interplay between Geopolitics, Economics, and Investments." He also publishes the blog "Klement on Investing" on Substack.
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04-22-24 0701ET
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