With the U.S. dollar strengthening and the Federal Reserve looking at tightening its monetary policy, the various U.S. market sectors and related exchange traded funds could behave differently in a strong USD environment.
The Trade Weighted U.S. Dollar Index has increased 15% over the past year and is at its highest level in over 10 years, writes Karen Wallace for Morningstar.
Consequently, investors should be aware that the stronger dollar could affect company sales abroad, especially for large multinational companies with significant overseas exposure.
“It’s generally a headwind for U.S. companies that rely on exports to other countries because the currency-translation effects mean that products made and sold in the U.S. (and priced in U.S. dollars) are more expensive to a foreign buyer,” Wallace said. “During periods of relative strength for the greenback, export growth tends to slow.”
The percentage of foreign sales among the S&P 500 companies was about 50% in 2014. Information technology and energy companies are among those with the largest overseas sales exposure.
Consequently, if the USD continues to strengthen against the basket of foreign currencies, ETFs with exposure to the technology sector, including he Technology Select Sector SPDR (NYSEArca: XLK), iShares U.S. Technology ETF (NYSEArca: IYW) and Vanguard Information Technology ETF (NYSEArca: VGT), could falter.
Additionally, investors may want to watch out for energy sector plays, like the Energy Select Sector SPDR (NYSEArca: XLE), Vanguard Energy ETF (NYSEArca: VDE) and iShares U.S. Energy ETF (NYSEArca: IYE).
ProShares also recently came out with a suite of ex-sector S&P 500 ETFs that promise to track the S&P 500 without a specific sector. For example, S&P 500 Ex-Energy ETF (NYSEArca: SPXE) will try to reflect the performance of the S&P 500 Ex-Energy Index, which provides exposure to S&P 500 companies with the exception of those included in the Energy Sector. The S&P 500 Ex-Technology ETF (NYSEArca: SPXT) will reflect the performance of the S&P 500 Ex-Information Technology & Telecommunications Services Index, which holds S&P 500 companies with the exception of those included in the Information Technology and the Telecommunication Services Sectors, or collectively the Technology Sector. [S&P Without the Pulp: New S&P 500 ‘Ex-Sector’ ETFs Introduced]
On the other hand, telecommunication services and utilities have the lowest reliance on global sales. Investors can track the telecom sector through ETFs, including the iShares U.S. Telecommunications ETF (NYSEArca: IYZ), Vanguard Telecommunication Services ETF (NYSEArca: VOX) and Fidelity MSCI Telecommunication Services Index ETF (NYSEArca: FCOM).
For utilities exposure, investors can look to the Utilities Select Sector SPDR (NYSEArca: XLU), Vanguard Utilities ETF (NYSEArca: VPU) and iShares U.S. Utilities ETF (NYSEArca: IDU).
Meanwhile, financials, materials and health care have estimated global sales somewhere in the single digits, so these sectors are not completely immune to an appreciating dollar.
For more information on the market sectors, visit our sector ETFs category.
Full disclosure: Tom Lydon’s clients own shares of XLU.
Max Chen contributed to this article.