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  • U.S. Dollar strength and weakness contributed to technology stocks declining and rallying this year.
  • Technology stocks are most exposed to revenue overseas.
  • U.S. Dollar strength isn't guaranteed to continue.
  • Buy these four retailers to avoid currency conversion risk.

A lot of attention focuses on the inverse relationship between the Dollar and commodities, particularly gold. However, commodities aren’t the only basket to suffer recently because of Dollar strength. For example, after the Dollar bottomed in mid-August, technology stocks tumbled, taking the index with them.

The reason may be as simple as remembering that the technology sector is the basket most heavily exposed to overseas revenue. According to Goldman Sachs, 59% of technology revenue comes from outside the United States. So converting all those foreign sales back into Dollars creates a powerful headwind to revenue when the dollar rises.

For instance, Microsoft's  (MSFT)  revenue was 4% lower last quarter because of currency conversion, and on Wednesday, Salesforce  (CRM)  lowered full-year guidance by $250 million because of currency headwinds.

According to Credit Suisse, U.S. corporate profits decline 1% for every 8% to 10% increase in the U.S. Dollar. Given this backdrop, perhaps it’s unsurprising that technology stocks performed poorly in the first half of the year when the U.S. Dollar  (UUP)  rallied against other currencies or that they rallied when the Dollar sold off from mid-July to mid-August.

Dollar strength isn’t guaranteed

In “Being Long the U.S. Dollar Isn't as 'Easy' as Some Say,” Real Money Pro’s Carley Garner reminds us that extrapolating currency trends can be a mistake. She writes,

“It wasn't that long ago the masses assumed being short the dollar was the "easy" trade. In January 2021, the U.S. dollar index, traded on the ICE exchange, was trading near 90.00 and the world was bearish due to aggressive money printing and loose monetary policy. Very few gave the dollar a chance at avoiding Armageddon, let alone rallying deep into the 100.00s!”

Yet, that’s what’s happened. The so-called easy money play to short the Dollar failed to pan out. Instead, the Dollar has risen sharply on the back of increasing interest rates.

Back to Garner:

“According to the Bullish Consensus Index, only 28ish% of market professionals polled are bullish on the euro against the dollar and almost 70% are bullish on the U.S. dollar. This is the mirror image of what we saw in early 2021 before a trend reversal…Sentiment readings, as well as the Commitments of Traders Report, suggest the market is "bulled up."

This leaves traders vulnerable to a reversal because even the sharpest of uptrends eventually run out of buyers.

We think that the inflection point could be near recent highs at about 109.00, but if the Jackson Hole symposium adds fuel to the fire, the last hurrah rally to multi-year trendline resistance is possible. That would put prices closer to 113.00!...While we aren't counting on that to occur, it is a possibility. In any case, the upside is most likely limited from here [emphasis mine].”

If the Dollar’s upside is limited, “bulled up” traders could get caught offside, providing fuel for a falling Dollar and a nice tailwind for technology stocks. In addition, traditionally weak seasonality could provide a catalyst for a sell-off.

Back to Garner:

“In the case of the U.S. dollar, the currency is apt to experience weakness from early July through early October. This is based on data compiled over the last 30 years. It should be noted that data dating back only five years is slightly bullish for the greenback during this period.”

Indeed, a weak Dollar would be good news for technology stocks, but to derail it may require a substantial shift in Central Bank policies worldwide. Inflation remains too high, resulting in negative real wages. As a result, the Fed’s been raising rates at a much more aggressive pace than overseas banks this year.

Real Money Pro’s Maleeha Bengali writes in “The Dollar Is Whispering to Investors, So Listen” that “the Fed is on an interest-rate tightening cycle given the difference between its Fed funds rate and estimated consumer-price inflation. The European Central Bank, riddled with even worse inflation, has yet to really raise interest rates, and is still providing monetary easing to an extent, despite the troubling inflation prospects.”

Bengali continues, writing:

“The ECB is unable to do anything, given stretched balance sheets and huge debt piles. The dollar may be overbought against the euro, that relationship is being driven by the dollar interest rate path more than Europe's fate…If the Fed does pivot, then we could see a massive collapse in the dollar, but that pivot seems much further away. Unless, of course, the system breaks down as it did back in 2019.”

Suppose we assume that the Fed is ahead of global interest rate policy. In that case, the Dollar could slide if it shifts to the sidelines after September, and European banks accelerate tightening. However, investors might want to hunt for stocks without overseas exposure if the Dollar trades sideways or breaks out to new highs.

In “4 Retailers to Consider to Avoid the Decimated Euro's Downer Effect on Earnings,” Real Money Pro’s Ed Ponsi shares some of his top picks with the Dollar at 20-year highs to the Euro.

He writes, “I'm expecting unfavorable exchange rates to become a common complaint when third-quarter earnings season begins in October…Companies that have little or no European exposure should have a clear advantage over their euro-dependent counterparts.”

He recommends BJ Wholesale  (BJ) , Dollar Tree  (DLTR) , Dollar General  (DG) , and CVS Health  (CVS) . Dollar General has a “handful” of stores in Mexico; otherwise, they aren’t exposed to revenue outside North America.

The Smart Play

The U.S. Dollar is testing its mid-July highs, and it’s anyone’s guess if it breaks out or heads lower, supporting stocks, including technology plays.

Whether it moves to new highs or trades sideways, there’s good reason to consider Ponsi’s ideas. For example, BJ Wholesale, Dollar Tree, and Dollar General benefit from shoppers trading down to less-costly shopping alternatives. Likewise, CVS’ exposure to pharmacy and OTC drugs makes its revenue less elastic to economic weakness.

If you want to buy technology stocks, though, you should pay attention to what happens next to the Dollar. If it rallies, it could also make it harder for technology stocks to rally.

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