The funds set to benefit from a strong dollar

July 2014 marked the turning point when the long awaited rally in the dollar finally arrived. The greenback then rallied around 10% against a basket of global currencies as shown below as shown in the chart below.

 

That may sound a lot but if we put it into a context, the dollar has been on downward trend since the 1980's, as shown below:

 

Economists are almost unanimous (which is always dangerous – see later in this article) in their positive outlook for the US economy and the strength of the dollar in 2015. As the US economy strengthens the Federal Reserve is expected to raise interest rates by mid 2015. Higher rates make the dollar relatively more appealing to hold, so driving demand and the currencies relative value up. Conversely, other central banks (i.e. Japan) are continuing to print money (which weakens their currencies) or are expected to start doing so soon (in the case of the European Central Bank)

Yet a strong dollar is not good news for everyone. For example, emerging market equities and commodities, such as oil tend to perform badly. So what should you invest in if the dollar does indeed continue to rally?

Funds to buy to benefit from the dollar rally

The simplest way is to buy an ETF which will directly  benefit from a strengthening dollar relative to another currency. The most crowded trade at the moment is long dollar / short euro (i.e a bet that the dollar will strengthening versus the euro). So for the brave, buying an ETF such as ETFS Short EUR Long USD would give them direct exposure to the currency trade.

Yet, rather than directly play the currency markets investors could gain exposure via a global bond fund. A good actively managed bond fund would be M&G Global Macro Bond as it is positioned to benefit from a rising dollar. But not only that the manager can actively alter the fund’s duration and credit exposure to boost your bond returns. The fund has an ongoing charge of 1.4%.

Alternatively look at Threadneedle Dollar Bond. Unsurprisingly, both of these funds have also been identified as 2 of the best 'low risk' funds at the start of 2015 by our 80-20 Investor momentum algorithm.

Investors looking for a cheaper alternative might want to look at iShare $ Treasury Bond 7-10yr ETF with an ongoing charge of just 0.2%.

Beware of a consensus

As I've mentioned, at the moment the most crowded investment trade is long dollar versus / short euro. Whenever there is a consensus you need to be wary, as crowds have a habit of being wrong. When the consensus is so one way, any evidence to the contrary can cause a market overreaction. So is this likely?

There are signs that the US dollar is not the haven it was in the years post the financial crisis. Historically the strength of the dollar moved in the opposite direction to US equities and the strength of this negative correlation peaked in late 2012, as shown below:

The green line is the US stock market (S&P 500) and the orange line is the dollar index (a measure of the dollar against a basket of global currencies)

 

So in simple terms, as equity markets sold off when investors were scared they bought the dollar as a safety play. But since then this relationship has broken down. In fact, at the end of 2014 it turned marginally positive. Or in other words when US equities sold off then so did the dollar!

The more observant might have noticed that during December the dollar slipped when the markets became spooked by the prospect of a Greek exit from the eurozone. This new trend positive dollar-equity trend started when the Federal Reserve started planning to end (or taper) their money printing programme back in 2013, as shown below. Here is the same chart as above but for 2014:

 

While it is not a strong correlation this new trend for the dollar has happened for 2 reasons:

• economists are unanimous in their opinion on the strength of the US economic growth in 2015
• markets expect the Federal Reserve to start raising interest rates in 2015, which is positive for the dollar

So why is this important?

The US dollar appears to be slowly becoming a growth play rather than a haven in times of uncertainty. If this trend doesn't reverse then if concerns emerge about US economic growth then US equities and the dollar could sell off.

 

(charts produced via bloomberg)

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