If you've been considering a trip abroad, 2017 might be a good year for such an excursion. Most economic indicators, including the Federal Reserve's December 2016 increase of interest rates and signals that more rate increases are to come, suggest that the U.S. dollar is likely to strengthen throughout the year.
In fact, Wells Fargo Investment Institute is expecting the U.S. dollar to gain about 5 percent in value compared to the euro and the Japanese yen — two other important currencies frequently benchmarked against the dollar. That means your money could buy more in those countries.
But a strengthening dollar means more than just less expensive vacations. It also can have widespread impacts on financial markets, potentially impacting your investment portfolio. To prepare for possible fluctuations, it's important to implement sound strategies for both domestic and foreign investments.
Assessing the "competition"
In Europe, even though strong investment opportunities still exist, market volatility, fueled by Brexit (the British exit from the European Union) and unrest over other political issues, including immigration, could present challenges for the euro, says Paul Christopher, Head Global Market Strategist at Wells Fargo Investment Institute.
The euro could weaken further if more countries follow the United Kingdom's lead and choose to exit the European Union. But even if they don't, Christopher says, a more fractious Europe makes it less likely that needed financial and currency reforms will occur.
In Japan, meanwhile, the yen has shown signs in early 2017 of trending downward after a relatively healthy 2016.
By comparison, the U.S. dollar and economy have been stable and strong, attracting investors from overseas, Christopher says. As these investors buy U.S. dollars, its value should increase. In addition to U.S. stocks, bonds, and Treasury securities, many global commodities, such as oil, also are bought and sold in dollars, encouraging demand for the currency.
A stronger dollar often results in a weaker market for U.S. exports and reduced profits from overseas operations, which can be a drag on U.S. corporations. But even with those possibilities, Wells Fargo Investment Institute is expecting 6–7 percent growth in U.S. corporate earnings.
Christopher says that while the outlook for U.S. investment sectors is positive, he believes investors shouldn't be dumping overseas assets and putting all their holdings in dollar-denominated investments.
Even with a weaker euro, companies within the 19-state Eurozone still have strong prospects, he says. And because European companies are more likely to pay out dividends than U.S. equities, investors focused on income may find that European stocks still have an important place in their portfolios. Still, if you're holding investments in a foreign currency (such as a Japanese equity) and the dollar gains strength against that currency, your equity has to appreciate even more to make up for the change in return due to the currency movement.
Keeping your eyes on change
Christopher says the long-term expectation is that international economic development should continue to support international investment returns. Consequently, he recommends that investors maintain a globally diversified portfolio. That includes owning international securities, as well as diversifying among asset classes such as stocks, bonds, and real estate.
All that said, there's plenty of economic and financial uncertainty down the road, especially in late 2017 and 2018, as policy changes driven by a Republican Congress and President Trump take effect.
A move toward deregulation in the U.S. should stimulate business activity and support the greenback. Much depends on the new administration's trade policies. A move toward more trade restrictions, such as tariffs, could make imports more expensive, reduce exports, and undermine the dollar's value. However, a different idea being talked about in Congress is to tax imports but not exports. If U.S. consumers buy less from the rest of the world, the U.S. trade deficit should narrow and support further dollar appreciation. There is still much uncertainty about how Washington will approach President Trump's promise to increase U.S. employment via trade. There is room for the dollar to experience swings in value.
Even as the short-term view still points to earnings growth in 2017, and the long-term international outlook remains favorable, financial markets may experience volatility as they react to the news of the day. Christopher says investors should consider any big swings as either buying opportunities (when the market drops suddenly) or a chance to take profits (when the markets spike).