The U.S. dollar has recently been living up to its status as the world’s reserve currency, outperforming major rivals such as the British pound, Japanese yen, euro and the dollars of Australia and Canada. For all the fretting about a strong dollar’s potentially adverse impact on stocks, the reality is U.S. equities have moved higher with the greenback.
It would be best to say “some” stocks are joining the dollar on the upside because some sector ETFs are being left behind, including technology and predictable suspects such as materials funds. However, a strong dollar does not mean investors need to avoid all sectors. [ETFs That Benefit From a Rising Dollar]
A look back at a recent period of dollar strength could provide important clues regarding which sector ETFs could benefit should the greenback continue climbing higher. Research from ETF provider WisdomTree (NasdaqGS: WETF) indicates that the dollar, not surprisingly, soared following the end of the Federal Reserve’s second round of quantitative easing.
From August 2011through early July 2012, the PowerShares DB Dollar Bullish (NYSEArca: UUP) climbed 7.6%. Over the same time, seven of the nine sector SPDR ETFs traded higher, too. The two laggards were the Energy Select SPDR (NYSEArca: XLE) and the Material Select Sector SPDR (NYSEArca: XLB). [S&P Downgrades Materials ETFs]
One of the best-performing SPDRs over the aforementioned time horizon is one that some market observers believe would be vulnerable to a strong dollar: The Consumer Staples Select SPDR (NYSEArca: XLP). XLP constituents such as Procter & Gamble (NYSE: PG), PepsiCo (NYSE: PEP) and Colgate-Palmolive (NYSE: CL) derive substantial portions of their sales from overseas market. A strong dollar means sales accrued in Europe and Japan, as two examples, those euros and yen are converted into fewer bucks.
That did not stop XLP and the Vanguard Consumer Staples ETF (NYSEArca: VDC) from climbing an average of 16.4% from August 2011 until about the time QE3 was announced. XLP was up 17.1% over that time, making it the best performer among the nine sector SPDRs.
Identifying the catalyst for soaring staples stocks in a strong dollar environment is not difficult. A well-heeled dollar usually means falling commodities prices. While XLP and VDC were racing higher following the end of QE2, the PowerShares DB Commodity Index Tracking ETF (NYSEArca: DBC) tumbled 15.1%.
DBC offers some exposure to some of the soft commodities used by staples companies such as corn, soybeans and sugar, indicating that ETFs such as XLP and VDC may actually be ideal strong dollar plays.
Past performances are never guaranteed to be repeated, but maybe this one is already enjoying a sequel. In the past 90 days, UUP and XLP are both up 2.3% while DBC is down 4%.
Vanguard Consumer Staples ETF
ETF Trends editorial team contributed to this post. Tom Lydon’s clients own shares of Procter & Gamble.