How to Profit From a Stronger Dollar

— -- Investors need to keep abreast of various economic factors that affect the markets, and one of the trickiest among these is currencies. Knowing where the American dollar stands among global currencies can be essential to determining what stocks to own and which ones to avoid.

Even though this is a complex area, you don’t have to be a Nobel laureate in economics to get a basic grip on how trends in the dollar’s value against other major currencies might affect your portfolio, at least for the short run; anticipating the effects of major currency fluctuations on the market for the long term is another thing entirely.

Currencies are measured against one another in terms of their relative strength or weakness. The dollar is valued in currency markets according to its strength against other major stable currencies, including the yen and the euro.

Currently, the dollar is stronger than it has been since 2010. After bottoming out in 2011, it has been rising since, and is now up more than 15 percent since its 2011 trough. More technically, the U.S. Dollar Index, a standardized measure of the dollar’s strength against other currencies, has recently been around 85, having jumped from around 80 late in the summer — a significant increase. Generally, this is a good thing for U.S. stock markets because it attracts foreign money from investors seeking dollar-denominated returns instead of in their own currencies. Money will flow to places where it’s treated best.

Also, because global oil prices are denominated in dollars, energy costs in the U.S. decrease with a strong dollar — a boon to the overall economy because it lessens industrial costs and thus increases company earnings.

Yet, from a revenue standpoint, a strong dollar can benefit some companies and hurt others. Companies that get much of their revenue from overseas, like American multinational consumer products manufacturers, take a bit of a hit when they bring home currencies that are weak against the strong dollar. This gives an advantage to companies that get all or most of their revenue domestically.

Many large U.S. companies are multinationals, so the true advantage of a strong dollar tends to go to small-cap and mid-cap companies in industries including insurance, domestic home building, domestic airlines and general merchandise retailing. Regardless of their size, domestic retailers benefit from a strong dollar two ways: The cost of their inventory purchased overseas goes down and the ability of their customers to buy is enhanced by the strong underlying economy. Thus, companies like TJX (owner of Marshalls and T.J. Maxx), which sell discount name-brand merchandise in a value-seeking market, love a strong dollar.

So a strong dollar is all upside for CarMax, a car dealer which only operates domestically, but not as much for Ford, because it sells cars overseas.

Nor does the strong dollar have a downside for Southwest Airlines, which has few overseas routes, but it’s a mixed bag for competitors that collect a lot of fares in foreign currencies, like United and Delta, or associated industry manufacturers, like Boeing, which sells planes all over the world.

Using this same mind-set, you want a drugstore company that operates inside the U.S. instead of a drug company that sells globally — CVS, not Pfizer.

A strong dollar tends to plateau, and during the current plateau investors can benefit by investing in industries that are largely domestic, such as homebuilders like Hovnanian and the Ryland Group. The sweet spot of the strong dollar is companies that rely largely or exclusively on domestic revenue but are large enough to attract foreign investment. Retailers like Macy’s and Nordstrom are in this narrow category.

In the energy industry, think in terms of domestic sourcing and distribution — oil drillers who operate and sell domestically, such as Whiting Petroleum Corp.

Of course, over the long term, all companies, regardless of size or the reach of their markets, should want a strong dollar. A significantly weakening American dollar not only reflects a weak U.S. economy, but also eventually can mean a serious loss of purchasing power. The classic historical extreme of currency devaluation, reflecting hyperinflation, is the Weimar Republic (now Germany) in the early 20th century, when people needed a wheelbarrow full of cash to buy just a load of bread. Well short of this extreme, significant inflation can make it hard for those whose paychecks don’t keep up (and few do) to buy a new car or make a down payment on a house.

And as a nation’s or region’s economy goes, so go its currencies. Currently, most European economies are in dire straits, ultimately hurting the euro and other European currencies, while the U.S. economy is chugging along and picking up steam, strengthening the dollar.

Investors around the world are looking for the same thing they are here: GARP (growth at a reasonable price). Foreign investors have to have some place to put their money, and the American stock market is all the more appealing because of the dollar’s current strength.

A strong dollar also buttresses the American bond market because investors tired of getting next to nothing abroad can benefit, even at current low domestic interest rates, by putting their money into bonds denominated in the strong dollar.

The long-term future of the dollar is anybody’s guess, but in the near- and mid-term, the improving U.S. economy, versus the suffering economies of Europe, bode well for good old “E pluribus unum.” Europeans are printing more and more currency, making it less scarce and less in demand, while the Federal Reserve this week announced that it is ending its economic stimulus program. This will mean fewer dollars in circulation, upping their value against rising global demand for the currency.

Currency markets aren’t something that most investors should obsess over. But it’s always a good idea to know where the dollar stands when making major investing decisions or rebalancing your portfolio.

Any opinions expressed are solely those of the author and not of ABC News.

Dave Sheaff Gilreath is a founding principal of Sheaff Brock Investment Advisors LLC. He has more than 30 years of experience in the financial services industry, beginning with Bache Halsey Stuart Shields and later Morgan Stanley/Dean Witter. At Sheaff Brock, he shares responsibility for setting investment policy, asset allocation and security selection for the company's managed accounts. He also consults with the clients on portfolio construction. Gilreath received his Certified Financial Planner® (CFP) designation in 1984. He attended Miami University in Oxford, Ohio, where he earned a B.S. degree.