The U.S. dollar has been shining bright in recent months. A 6.6% third-quarter gain for the PowerShares DB US Dollar Index Bullish Fund (NYSEArca: UUP), the U.S. Dollar Index tracking ETF, confirms as much.
On a downbeat note, periods of shine for the dollar can remove some of the luster from sectors that benefit from a weaker greenback. The good news is that when dollar rallies give way to pullbacks, weak dollar sector plays often follow dollar retrenchment with impressive out-performance.
“Since 1971, there have been 20 quarters in which the U.S. dollar has seen a drop of at least 5 percent,” Bespoke Investment Group’s Paul Hickey told CNBC earlier this week. “In the quarters following, three sectors have historically rebounded: Materials, industrials and energy.”
Because commodities, including oil, are denominated in U.S. dollars, sector exchange trade funds such as the Energy Select Sector SPDR (NYSEArca: XLE) make for predictable beneficiaries of weak dollar environments. Investors have been reminded of that fact again this year.
As UUP has surged this quarter, XLE, the largest equity-based energy ETF, has tumbled 9.4%. While XLE makes for an obvious weak dollar play, investors should not avoid the ETF if interest rates rise. If past history repeats, they will want to embrace XLE. During the last Federal Reserve rate tightening cycle in 2004 through 2006, XLE was the standout among the nine sector SPDR ETFs, soaring nearly 122% over that period. [Best Sector Ideas for Rising Rates]
The Materials Select Sector SPDR (NYSEArca: XLB) has not shown the same third-quarter sensitivity to the strong dollar as XLE and that has helped the materials ETF keep its head above water with a 0.3% gain. Hickey told CNBC his preferred materials pick is Dow Chemical (NYSE: DOW).
Dow, like rival DuPont (NYSE: DD), has drawn the interest of an activist investor looking to break the company into two units to unlock shareholder value. DuPont and Dow combine 20.4% of XLB’s weight. [Peltz Pushes for DuPont Breakup]
The Industrial Select Sector SPDR (NYSEArca: XLI) has been crimped a bit by the stronger greenback, falling 3% this quarter. Industrials’ inverse relationship with the U.S. dollar has previously been on display. From July 2013 through the end of last year, UUP fell almost 5% but XLI gained 22%. Like, XLE and XLB, XLI outperformed the S&P 500 during the 2004-2006 Fed tightening cycle.
Energy Select Sector SPDR
