The Australian dollar has tumbled to its lowest level this calendar year and it looks likely to extend its losses against the US currency in the near-term at least.
Australian equity investors who view this trend with apathy should rethink their views as the exchange rate will have a bigger impact this time round on ASX-listed stocks than you'd might think.
The Aussie battler was fetching closer to US77 cents yesterday before it tumbled to US76.04 cents this morning. That may not sound like much to you, but that is a big move in currency markets.
More significantly, the drop means the Aussie has broken out of its two-month trading band of between US79.5 cents and US76.5 cents, and unless it recovers quickly, this trading band will be reset lower.
There are more reasons to think that the Aussie will weaken further against the greenback than not! One of the key indicators that investors should be watching for a heads-up is the Treasury market (US government bonds).
Yields on the benchmark 10-year looks set to break above 3% in the coming days. If that happens, experts think the yield is likely to rally to 3.25%. The higher yields will fuel US dollar strength and that means we are likely to see the Aussie trade with a "75" in front of it instead of a "76" pretty soon.
The impact of this will be felt across almost every stock on the S&P/ASX 200 (Index:^AXJO) (ASX:XJO). Companies with large US exposure will be the most obvious ones to benefit from the stronger US currency as their net profit line will be bolstered when they convert their US dollar earnings back into Australian dollars.
This group includes the likes of building materials supplier Boral Limited (ASX: BLD), plumbing and water solutions group Reliance Worldwide Corporation Ltd (ASX: RWC) and medical device makers Cochlear Limited (ASX: COH) and RESMED/IDR UNRESTR (ASX: RMD) – more commonly called ResMed – just to name a few.
Our resource stocks will also benefit as commodities are sold in US dollars. But it's those with larger local operations like Independence Group NL (ASX: IGO) and OZ Minerals Limited (ASX: OZL) that will benefit the most as their cost base is denominated in falling Australian dollars while their income is denominated in the rising greenback.
If you thought your holdings of the big banks like Commonwealth Bank of Australia (ASX: CBA) and other domestically focused companies will be relatively insulated from the exchange rate – think again. Our banks are heavily reliant on offshore funding and will be impacted by bond yields and the rising US dollar.
The exchange rate will also impact on the recommendations of strategists and other asset consultants who could be biased against domestic stocks.
Let's also not forget how a weaker Australian dollar could impact on our economy and the interest rate deliberations of the Reserve Bank of Australia!
This also means that small cap stocks may struggle to keep outrunning their larger counterparts as they have a whopping 12 percentage point lead over the ASX 200.
We could be entering a period where we could see the big gap in performance between the top 200 stocks and the S&P/ASX SMALL ORDINARIES (Index:^AXSO) (ASX:XSO) narrow.
But there's another group of stocks that are well placed to outperform this year. The experts at the Motley Fool are very bullish on the outlook for these stocks – regardless of the exchange rate.
Follow the free link below to find out what these stocks are and why they should be on your watchlist.
