Question: How does the dollar affect the stock market? Should I be paying attention to its swings?

J. Chen

Dear J. Chen,

Yes. The dollar does indeed affect the market. And, yes. It's smart to know how strong or weak it is against the value of other currencies. An easy way to track its movement is to follow the Dollar Index (DXY) which measures the U.S. dollar against a basket of six major currencies - the euro, Japanese Yen, British Pound, Canadian dollar, Swedish Krona and Swiss Franc. It trades on the NYBOT (New York Board of Trade). You can search for this index via your favorite search engine.

As of the second week in November, the dollar fell to its lowest level in 15-months and has remained approximately at that level, with slight movements up and down.

At the same time, interest rates are hovering around 1%. The average money market fund is paying 0.04%, a one-year CD, 0.89% and a 5-year CD, 2.20%.

This combination -- low interest rates and a low dollar -- is essentially a positive for the stock market. It means investors are no longer drawn toward savings vehicles or U.S. Treasuries and instead are drawn toward somewhat riskier assets with greater growth potential, such as stocks, bonds, and even commodities and gold.

Multinational companies

The stock sector that traditionally fares well when the dollar is weak is multinationals. Multinationals are large U.S. companies that sell a good portion of their products abroad. (Most experts define multinational as being companies selling over 50% of their products and services outside the U.S., but the 50% figure is not a rigid definition.)

Why multinationals? When the dollar is down, U.S. goods cost less for foreigners to buy. This in turn increases sales for these companies.

Other considerations

At the same time, there are signs of economic recovery in many parts of the world which likewise encourages investors to bet against the dollar and buy stocks.

One point to keep in mind, however, is that U.S. manufacturers that rely on using foreign parts or materials, are forced to pay more for those parts and materials when the dollar is weak. The next reaction in this chain of events, is higher prices for American consumers buying imported items.

Bottom Line: Consider strong, well managed multinational companies with low debt levels and domestic manufacturers that have become more competitive.

Good luck!