The U.S. dollar has become one of the critical macro drivers of the markets. A weakening Japanese yen started some of this latest macro trade in 2012—as the yen weakened and Japanese stocks1 soared over the last two-and-a-half years.
Currency influences returns of stocks or markets when in the case of large exporters that derive much of their sales from foreign markets. There are a number of ways currency can flow through to company sales or other accounting metrics:
• Revenue translation from foreign functional currencies is different than revenue from U.S. dollars. If a U.S. company keeps its prices constant in local currency terms, a declining euro or yen means less revenue translated back into U.S. dollars. If firms raise their local prices to try to keep their U.S. dollar revenue the same, they face the risk of becoming less competitive, of lowered demand and declining revenue.
• Cash Held Abroad: If companies keep cash in foreign markets without any hedges in place, they can see a decrease in the cash on their balance sheets. There were 24 companies that saw a 7% loss in the total value of their cash in the first quarter of 2015.4
If the U.S. dollar continues to strengthen, this is likely to provide a continued headwind for the companies with meaningful revenue and business exposure in foreign markets. By contrast, if the U.S. dollar reverses, these firms will benefit.
WisdomTree designed two new U.S. equity factor Indexes to help position accordingly based on a view of the U.S. dollar’s direction.
• U.S. Local Economy Stocks = WisdomTree Strong Dollar U.S. Equity Index: These are firms that derive more than 80% of their revenues from within the United States. These companies tend to be less impacted by a strong-dollar environment.
• U.S. Exporters = WisdomTree Weak Dollar U.S. Equity Index: These are firms that derive at least 40% of their revenue from exports, which means they tend to be more impacted by a strong-dollar environment.
Geographic Revenue Distributions Make a Strong Statement
Since the primary selection methodology involves screening for geographic revenues, this is an important factor to consider. There is a big contrast between the Indexes.