Why Things Are Looking Bad For The Dollar And Which Stocks To Buy If It Weakens

The strength of the U.S. dollar has thrown a wrench into the works for gold and other areas of the market. The Dollar Index has been trending roughly lower since mid-July, but it reversed on Tuesday, renewing its year-to-date rise.

However, Evercore analysts are predicting that the dollar will weaken, and if or when it does, they expect several stocks to outperform.

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Implications Of The Dollar's Movement

The Dollar Index surpassed 108 in July, its highest level in two decades, and it fell to about 105.5 before bouncing and climbing to around 106. As a result, things aren't looking so good for Evercore's dollar-related thesis in the near term. However, as the macroeconomic factors have demonstrated recently, it doesn't mean we won't see another reversal before long.

When investors started to hope that the Federal Reserve would hike interest rates less aggressively than previously expected, risk sentiment turned bullish. Stocks rallied while bond yields declined, and the dollar's seemingly unfettered rise halted.

Evercore's report comes amid Tuesday's rally in the dollar. The firm's analysts see rising risks to the dollar's dominance and advise investors to target stocks that should benefit from a weaker dollar. Evercore cited two factors that should drag the greenback down.

Why The Dollar Could Reverse Again

In the short term, the firm's analysts expect softening inflation expectations, which may enable the Fed to slow its pace of monetary tightening or even pause it. The Evercore analysts noted that this scenario would moderate the differentials in interest rates versus other major economies that support the U.S. dollar. They added that a pause in tightening has historically resulted in a rally in equity prices, although with elevated volatility.

Over the long term, Evercore warned that service costs on U.S. government debt are likely to hit new record highs on the back of quantitative tightening. Meanwhile, the secular rise in interest rates and Washington's ever-climbing debt levels could pressure the dollar, particularly its status as the reserve currency of the world.

How To Pick Stocks Amid A Weakening Dollar

According to Evercore analysts, investors can play their expectations for a weakening dollar by targeting stocks with the highest exposures to international markets. Other good plays could include those who enjoy a competitive advantage through a weaker greenback. Additionally, such companies should benefit of the rest of the world enjoys improving growth relative to the U.S.

Evercore's group of so-called "Dollar Down Dominators" consists of stocks in the technology, communication services, consumer staples, consumer discretionary, industrials and energy sectors. The firm said these sectors are particularly sensitive to the dollar.

Evercore analysts select companies with more than 70% of their revenue coming from international markets and high short interest. They also look for companies that have been underperforming their peers year to date.

Top Picks For A Weaker Dollar

For example, Evercore's top pick is NVIDIA, which captures 84% of its revenue overseas and has been underperforming its sector by more than 20% year to date. Short interest in the chipmaker is also high. Fellow chipmaker Intel was in second place, and Microchip Technology also landed in the top 10. Western Digital rounded out tech's inclusion in the top 10.

Otis Worldwide and Expeditors represent the industrials sector, while energy's lone entrant was Schlumberger. Other stocks included in the top 10 were Estee Lauder, Newmont and Celanese.

Avoid These Names If The Dollar Weakens

On the other hand, Evercore advised investors to avoid stocks from the above sectors that capture less than 30% of their revenue overseas, have low short interest and have underperformed their peers year to date. Among the names in this group were Lockheed Margin, Devon Energy and Kraft Heinz.