How to invest when the dollar is king

Political turmoil has recently shone a spotlight on the influence currencies have on investment performance – and there is one that has a bigger impact than any other.

The US dollar has emerged as the obvious winner from the geopolitical chaos of 2022. Despite a slump on Tuesday, caused by a decline in the housing market, the ICE US dollar index – the benchmark which measures the greenback against global currencies – is up almost 15pc in the year to date.

A key driving force behind the appreciation of the US dollar is global uncertainty. Rob Burgeman, of wealth manager RBC Brewin Dolphin, said: “With the invasion of Ukraine and the heightening of geopolitical risk, there was a flood of money into the US, which saw the value of the dollar rise against pretty much every currency.”

The dollar has also benefited from relentless rate rises by the Federal Reserve, attracting foreign investors who regard the dollar as a safe haven for their money.

Because of its outsized role in the world economy, when something has an impact on the dollar, it affects everyone, including British DIY investors, many of whom will have exposure to US equities. Almost 70pc of the MSCI World Index, an international equity index, is made up of American stocks.

Some of the steepest declines in equity markets this year have come from the US market, particularly in growth sectors like technology and communication services. The blue-chip S&P 500 index was down three quarters in a row in September for the first time since the financial crisis.

But there is a silver lining for UK investors who have been hit by US exposure. As American share prices have plummeted, British investors have seen more modest falls in their portfolios compared to their US counterparts because the pound has fallen at the same time.

Jason Hollands, of the investment firm Bestinvest, said: “While the S&P 500 index of US shares is down 19pc this year, in pound terms a UK investor would have suffered a far less severe decline of 4pc – unwelcome, but not a disaster. And instead of the 22pc decline in global equities, the pound-based investor has endured a far less brutal 7pc dip.”

If a US stock performs well, then a UK investor will see a double benefit: a capital gain and a currency gain.

Mr Burgeman recommends some of what he termed the “stalwarts” which are modestly rated but still offer attractive longer-term growth prospects. He said: “I would consider Johnson & Johnson (up 2pc in dollar terms, but up 22pc in sterling terms), Walmart (down 4pc, but up 16pc in sterling terms) and Texas Instruments (down 13pc in dollar terms and up 4pc in sterling).”

But Mr Hollands warned that investors should be cautious of using weak pounds to buy “vulnerable” US shares. The safer place for UK investors, he said, is in the FTSE 100, London’s benchmark index. He said: “These companies, which collectively make over 70pc of their earnings overseas (much of which is in dollars), are only modestly exposed to the UK’s domestic economy and will benefit from translating overseas earnings back into sterling reported profits and dividends.”

He also said investors can get exposure to large British companies through low-cost tracker funds such as the iShares Core FTSE 100 ETF, which has an ongoing charge of just 0.07pc, or more expensive actively-managed funds like Ninety One UK Alpha and Liontrust UK Growth.

What is good news for the dollar is usually bad news for the rest of the world’s economies. In a recent paper, Maurice Obstfeld, former chief economist at the International Monetary Fund, wrote that the appreciation of the dollar usually predicts downturns in emerging markets.

Yet Chris Metcalfe, of asset management company IBOSS, said emerging markets have held up well in the face of dollar strength, with India producing “a positive return for sterling investors in an overwhelmingly challenging investment period”.

With the Federal Reserve widely expected to deliver another rate rise next week, as it tries to keep inflation under control, experts believe the dollar will remain strong for at least several more months. But no rally lasts forever. Mr Hollands said: “A potential turning point could be when the Fed pivots away from its current aggressive rate hikes.”

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