5 Top Stocks To Buy On Dollar's Newfound Strength

The U.S. dollar maintains its strong rally since the start of the second quarter. The strength is primarily attributable to an uptick in U.S. government bond yields. Inflationary pressure owing to rising oil and raw material prices drove the U.S. 10-year bond yield higher.

Small caps, being U.S.-centric, are better poised to weather a stronger U.S. dollar. This category of stocks is ripping to fresh records as they are cushioned against the loss of competitiveness and currency translation impact of a stronger greenback. Needless to say that as the dollar rises; multi-nationals lose their competitive advantage, as foreign customers see U.S. goods as more expensive than non-U.S. goods.

What’s Driving Dollar?

The ICE U.S. Dollar Index, which measures dollar’s strength against a basket of major currencies, has been above the psychologically key 3% level since the beginning of April.

The greenback continues to rise in tandem with government bond yields. After all, currency traders tend to be drawn toward such currencies where interest rates are attractive. The yield on the 10-year Treasury note, a benchmark for interest rates, climbed above the 3% threshold to touch a seven-year high in the past week (read more: Resurgence of 10-Year Bond Yield: Winners & Losers).

Inflationary pressure, being more prevalent, led to a selloff of Treasuries and has kept the yield at elevated levels for now. Lest we forget, the Fed is set to take aggressive steps with respect to rate hikes this year. In fact, the Fed will release the minutes from its May 1-2 meeting this week, which may add to dollar’s strength and Treasury yields, provided they sound hawkish.

What Does a Stronger Dollar Mean for Stocks?

A rising dollar impedes earnings growth, which suggests that returns from the equity market might be subdued. Particularly, companies that derive a lion’s share of their earnings from overseas will be dealt the biggest blow. Such companies are exposed to foreign exchange risks between the United States and other countries they are operating in. Thus, if dollar gains strength, it tends to dent foreign sales of such companies.

S&P Global added that with every 1% rise in the greenback, large-cap companies with heavier U.S. concentration in terms of revenue generation have gained 71 basis points on average. For small caps, the correlation was way better. In fact, small caps have outperformed large caps so far this year (read more: Wall Street's Biggest Gains Come From Smallest Names!).

The tax cuts enacted this year along with deregulation should further benefit small caps, helping their profits accelerate in the near term. One of the popular measures of small caps, the Russell 200 Index, has risen 5.9% so far this year, while the broader S&P 500 gained only 0.6%. Year to date, nearly $3.7 billion has gone into small-cap U.S. equity exchange-traded funds, per FactSet. This category of U.S. stock ETFs has, thus, become the second-most popular category in the last decade.

5 Winning Stocks

Small caps are set to benefit from wider domestic revenue exposure which insulates them from the effects of a stronger dollar. Thus, investing in stocks with high domestic exposure in terms of revenue generation seems judicious. We have picked five such stocks that flaunt a Zacks Rank #1 (Strong Buy) or 2 (Buy).

American Public Education, Inc. (NASDAQ:APEI) provides online and campus-based postsecondary education. The company has a Zacks Rank #2. In the last 60 days, two earnings estimates moved up, while none moved lower for the current year. The Zacks Consensus Estimate for earnings has moved 1.9% up in the same time frame. The stock’s expected growth rate for the current year is 21.7% versus the Schools industry’s projected rally of 15.7%.

BankFinancial Corporation (NASDAQ:BFIN) operates as the holding company for BankFinancial, National Association that provides commercial, family, and personal banking products and services in Illinois. The company has a Zacks Rank #2. In the last 60 days, one earnings estimate moved up, compared with none in the opposite direction, at least when looking at the current-year time frame. Meanwhile, the Zacks Consensus Estimate for earnings has risen 1.5%. The stock’s estimated growth rate for the current year is 39.7% versus the Financial - Savings and Loan industry’s expected rally of 22%.

Century Communities, Inc. (NYSE:CCS) engages in the development, design, construction, marketing, and sale of single-family attached and detached homes in metropolitan areas of California, Colorado, Georgia, Nevada, North Carolina, South Carolina, Tennessee, Texas, Utah, and Washington. The company has a Zacks Rank #1. In the last 60 days, two earnings estimates moved up, compared with one lower for the current year. The Zacks Consensus Estimate for earnings has moved up 9.9% in the same time period. The stock’s expected growth rate for the current year is 47% versus the Building Products - Home Builders industry’s projected growth of 31.1%. You can see the complete list of today’s Zacks #1 Rank stocks here.

CPI Aerostructures, Inc. (NYSE:CVU) engages in the contract production of structural aircraft parts for fixed wing aircraft and helicopters in the commercial and defense markets. The company has a Zacks Rank #2. In the last 60 days, one earnings estimate moved up, while none moved lower for the current year. The Zacks Consensus Estimate for earnings has risen 21.1% in the same time frame. The stock’s estimated growth rate for the current year is 32.3% versus the Aerospace - Defense Equipment industry’s projected rally of 14.7%.

IEC Electronics Corp. (NYSE:IEC) provides electronic manufacturing services in the United States. The company has a Zacks Rank #1. In the last 60 days, one earnings estimate moved up, while none moved lower for the current year. Meanwhile, the Zacks Consensus Estimate for earnings jumped 58.1%. The stock’s expected growth rate for the current year is more than 100% versus the Electronics - Miscellaneous Components industry’s projected rally of 20.3%.

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