Rising inflation and a weakening dollar are not signs that investors are normally happy to see. But there are still ways to take advantage of a situation like this by buying the right stocks.
You may remember from Economics 101 that inflation is basically defined as “too much money chasing too few goods and services.” For the last four decades—except for brief periods—the U.S. hasn’t really been faced with the serious threat of inflation and a weakening dollar. In fact, the U.S. dollar has been fairly stable since America’s last bout with inflation in the 1970s, which has greatly benefited both the economy and the financial market.
In the wake of this year’s nationwide shutdowns, however, rising inflation has become a bigger potential threat. The good news, though, is that if inflation does make a comeback there are ways that you can take advantage of it as an investor. Accordingly, we’ll look here at some stocks that could actually benefit from a weakening dollar.
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Economists and pundits have predicted the return of inflation in the U.S. for many years to no avail. After the 2008 credit crisis, the Federal Reserve embarked on a quantitative easing (QE) strategy for many years to satisfy the market’s huge demand for liquidity. Yet, to everyone’s surprise, even this unprecedented “loose” money policy failed to move the inflation needle very much. A key reason why inflation hasn’t been a problem is that the production of goods and services in America has always managed to keep pace with money creation, in turn keeping inflation pressures in check.
But with this year’s economic shutdowns, activity has been sharply curtailed as many businesses were shuttered and fewer goods and services are produced. And while the U.S. services industry bounced back strongly in June (as measured by the ISM non-manufacturing index), a recent surge in coronavirus cases has caused many states to shut down businesses again, which could negatively impact activity going forward.
Meanwhile, money was bountifully supplied both by central bank intervention and U.S. government fiscal stimulus. With the money spigot running full force while goods and services production is curtailed, we now have the classic ingredients for inflation for the first time in a long while.
One sign that inflation may be rearing its ugly head soon is the U.S. dollar index (DXY), which has been sagging ever since the shutdowns began in late March. It’s important to keep in mind that the value of a nation’s currency is one way to assess the strength or weakness of its economy. Typically, a weakening currency means the economy isn’t living up to its full potential, so the greenback’s weakness is telling us that the economy isn’t as strong as it could be. The dollar index is down 11% from its high as of late July—a big loss (in percentage terms) for a normally stable currency.
While a weakening dollar can undercut the profits of companies that do business mainly in the U.S., firms with heavy exposure to foreign markets can actually benefit from a weaker dollar since the value of their products in foreign currencies increases as the dollar weakens. With that in mind, let’s take a look at four companies whose stocks should benefit from continued dollar weakness.
Stocks to Own for a Weakening Dollar
HP Inc. (HPQ) offers personal computers (PCs), laptops, printers, ink cartridges and 3D printing solutions. Formerly known as Hewlett-Packard, this well-known firm is the world’s second-largest PC vendor by unit sales (behind Lenovo). While HP’s print business suffered a pandemic-related slowdown this spring, demand for laptops and PCs have increased as more people are now working from home. Analysts expect HP’s per-share earnings to bottom out in the third quarter, then rebound strongly into 2022. Management has also expressed a commitment to aggressive share repurchases once the impacts from COVID-19 completely subside.
But another important—and often overlooked—variable is how much of the company’s top-line comes from overseas (around 60%). Its supply chain, moreover, is denominated in greenbacks, which means HP’s profit margins should increase as its costs decline due to a softer dollar. Long story short, a weakening dollar could finally push HP’s share price out of its trading range of the last few months. I would consider a decisive breakout above the 18 level in HPQ to be a sign that money is rotating into the stock. And if the dollar index remains weak in the coming months, the chances are good that a share price turnaround will be sustainable.
McDonald’s (MCD) is expected to report an earnings and revenue decline when it reports its latest quarterly results on July 28. (So watch out, this one could be quite volatile.) However, drive-through business has picked up at many of its international locations in the pandemic’s wake. including a well-publicized three-hour wait at one of its France locations and a two-mile line at a drive-through in Austria. McDonald’s has also managed to stay ahead of the competition, an example of which is its always-improving digital drive-through menu (which adjusts for time of day, weather and previous customer orders).
Most of the firm’s top and bottom lines come from its international fast food markets, which also happen to be growth drivers. Because of its huge international exposure, a weaker dollar will mean that its overseas operations will earn more, in turn increasing the likelihood of a stock price boost.
Science and engineering juggernaut DuPont de Nemours (DD) derives a large percentage of its profits from overseas sales. As such, a weak dollar tends to increase its earnings and often boosts its stock price. DuPont was recently upgraded by two well-known Wall Street institutions, and the firm has positioned itself to navigate through the choppy pandemic environment. It’s also focusing on high-demand areas such as biosciences, construction and electronics and semiconductors. The last time the dollar index showed sustained weakness in 2017, DuPont’s share price posted a 30% gain that year. A weaker dollar in the months ahead should provide a constructive tailwind for the stock. Earnings are expected July 30.
Mining companies also benefit from a weakening dollar, as commodity prices typically move inversely to the dollar index. One of the most sensitive industries to a soft dollar is gold mining, with gold being a quintessential inflation hedge. Worth mentioning is Kinross Gold Corp. (KGC), a senior mining firm that acquires, explores, and develops gold properties in the U.S., Russia, Brazil, Chile, Ghana, and Mauritania.
Miners don’t always have solid fundamentals, but Kinross boasts a strong balance sheet compared to most of its peers, including $2 billion in available liquidity; its P/E ratio of 14 is also below the industry average of 30. Analysts, moreover, expect the top line to grow 20% in Q2 and Q3. The current environment is also favorable, with energy costs low and gold at all-time highs in both the Brazilian and Russian currencies (which will have a powerful impact on cost structure and margins if it persists). A weaker dollar would give Kinross an added profit boost. Earnings are expected July 29.
Forecasting the dollar’s trend is a notoriously difficult task due to the myriad of variables involved. But if more states begin shutting down parts of their economy again in the coming weeks and months in response to COVID, the dollar will likely continue weakening as monetary stimulus continues while goods and services production declines. And if the dollar continues to weaken, the stocks mentioned here should be able to benefit from it.
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Timothy Lutts heads one of America’s most respected independent investment advisory services. Each week, Tim personally picks the single best stock in his exclusive Cabot Stock of the Week advisory. Build your wealth and reduce your risk with the top stock each week for current market conditionsLearn More