What the Falling Dollar Means for Client Portfolios

International stocks, too, are generally touted as a good investment when the dollar weakens, but not all international stocks or global indexes will benefit from a weaker dollar.

The EAFE index, which tracks major non-U.S. and non-Canadian equity markets in Europe, Australia, New Zealand and the Middle East, for example, has underperformed the S&P 500 by more than two percentage points over the past three months and as much as five times that amount year to date.

Tracie McMillion, head of global asset allocation strategy at the Wells Fargo Investment Institute, explains these performance differences are due to the different composition of the two indexes.

Technology and communication services constitute a much larger share of the S&P 500 index than the EAFE index — 25% and 11%, respectively, vs. 8% and 5.4%. The EAFE index is also more heavily weighted toward financials — 16% vs. 10% in the S&P 500.

Add Commodities

Wells Fargo Investment Institute believes U.S. investors should allocate their assets globally, including exposure to developed and developing markets, but favors U.S. stocks over foreign equities because investors need to match assets with the currency of their liabilities. Still, the institute has been recommending tactical changes to investor portfolios to take advantage of the dollar's weakness over the next 16-18 months, among them, a greater allocation to commodities, which are priced in dollars.

"We continue to like gold in a diversified portfolio," said McMillion noting the institute's target price for gold for 2021 is between $2,200 and $2,300 an ounce, up from about $1,990 currently. In addition to commodities and large-cap multinationals, McMillion likes U.S. mid-caps but not small-caps, which are more dependent on U.S. revenues and tend to underperform when the dollar rises.

Investors need "to consider how a weaker dollar impacts different investments," says Katy Kaminski, chief research strategist at AlphaSimplex Group, an affiliate of Natixis Investment Manager.

She views the dollar's weakness after years of unrelenting strength as "an indicator of a bigger issue," namely rising inflation down the road, due to the almost doubling of the Fed's balance sheets and trillions of dollars worth of fiscal relief during the pandemic.

"At some point something has to give," said Kaminski, adding that there could be a temporary 'correction' to the dollar's current decline though the long-term outlook calls for more weakness.

Kaminski also favors real assets, such as commodities, due to the dollar's drop. "We've seen commodity prices go to record lows," says Kaminiski. "That means there is only way to go, and that's up."

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• Fed Warns of Major Hit to Asset Prices If Crisis Grows
• 5 Reasons to Consider Investing in Europe and Japan