ETFs To Benefit & Lose From A Strengthening Dollar

The U.S. dollar is on fire once again, with the dollar index rising to a 16-month high against the basket of other currencies. The surge was driven by political malaise in Europe, especially growing uncertainty over a smooth Brexit deal and concerns over Italy's budget that has led to the decline in euro and sterling.

The appreciation in the greenback is further supported by the Federal Reserve’s latest FOMC meeting as well as an upbeat economy. The central bank reaffirmed its plan to raise interest rates for the fourth time this year as soon as next month and a potential for two more hikes by mid-2019. Meanwhile, the American economy looks exceptionally solid with robust job creation, strong GDP growth, a 50-year low unemployment rate, fastest pace of wage gains in nearly a decade, and rising consumer and business confidence (read: 5 Sector ETFs to Sizzle on Upbeat October Jobs Data.

On the other hand, a weakening Euro zone economy will continue to trigger euro-selling pressure going into the year end. Additionally, persistent slowdown in the Chinese economy due to the trade war between Washington and Beijing, is compelling investors to flee to the safer greenback.

Against such a backdrop, the bullish trend in the dollar is likely to continue through the end of the year.

Strong Dollar: Boon & Bane

A strong dollar will lead to a rally in the stock market as it attracts foreign money from investors seeking dollar-denominated returns instead of their home currencies. Additionally, energy cost in America decreases with a strong dollar, thereby lowering the industrial cost and increasing the profitability and propelling the overall economy.

While a strong dollar provides an edge to the domestic-focused companies, it makes dollar-denominated assets expensive for foreign investors, making U.S. multinational products uncompetitive, leading to lower demand and less profits. As such, companies having a higher percentage of international sales will likely underperform in a rising dollar environment. Moreover, commodities, emerging markets and gold mining stocks also get hurt by a strong dollar.

Given this, we have highlighted ETFs that should benefit from a strengthening dollar and the ones that will lose.

ETFs to Benefit

Invesco DB US Dollar Index Bullish Fund UUP: UUP is the prime beneficiary of a rising dollar as it offers exposure against a basket of six world currencies. The fund has so far managed an asset base of $552.8 million, while sees an average daily volume of more than 1 million shares. It charges 79 bps in annual fees and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook (read: Fed Meet Signals December Rate Hike: ETFs That Gained).

iShares Russell 2000 IWM: The strength in U.S. dollar, which makes domestic goods more expensive overseas, will drive the small-cap stocks higher. IWM targets the small-cap segment of the broad U.S. stock market, charging investors 19 bps in annual fees. IWM is the most popular and liquid choice in the small-cap space with AUM of $44.9 billion and average trading volume of around 21.4 million shares. It has a Zacks ETF Rank #3 with a Medium risk outlook.

iShares Currency Hedged MSCI EAFE ETF HEFA: Currency-hedged ETFs tend to win in a rising dollar environment as these strip out currency exposure to a foreign economy via the use of currency forwards or other instruments that bet against the non-dollar currency, while at the same time offer exposure to international stocks. HEFA offers exposure to a wide array of Europe, Australasia, and Far East equities, while at the same time provides hedge against any fall in foreign currencies relative to the U.S. dollar. It has amassed $3.3 billion in its asset base and trades in a good average daily volume of 499,000 shares. The product charges 35 bps in annual fees and has a Zacks ETF Rank #3 with a Medium risk outlook.

ETFs to Lose

Vanguard Mega Cap Growth ETF MGK: A strong dollar led to rough trading in blue chip companies, which derive most of their revenues from international markets. With AUM of $3.9 billion, this ETF offers diversified exposure to the largest growth stocks in the U.S. market. It charges 7 basis points in annual fees and trades in a good volume of around 143,000 shares a day on average. The fund has a Zacks ETF Rank #2 with a Medium risk outlook (read: 5 Top-Ranked Growth ETFs & Stocks to Tap Post Mid-Term Rally).

Invesco DB Commodity Index Tracking Fund (WA:DBC) : This fund tracks the DBIQ Optimum Yield Diversified Commodity Index Excess Return, which delivers returns through an unleveraged investment in the most heavily traded futures contracts on 14 physical commodities, with heavyweights going to the energy and agriculture. The fund charges 89 bps in annual fees, while trades in a solid volume of 2.3 million shares per day. The product has managed assets of $2.3 billion.

iShares MSCI Emerging Markets ETF (NYSE:EEM) EEM: A strengthening dollar would pull out capital from these markets, stirring up trouble for most emerging nations. This product offers exposure to large and mid-sized companies in the emerging markets. It is the most-popular and widely traded emerging market ETF with AUM of $28.8 billion and average daily volume of more than 73 million shares. The fund charges 69 bps in fees per year from investors and has a Zacks ETF Rank #3 with a Medium risk outlook (read: Emerging Markets Dip for 4th Successive Weak: ETFs in Focus).

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