The US Dollar Is Weak. Is Your Portfolio at Risk?

Key Concepts

Dollar Depreciation: The weakening of the US dollar against other major currencies.
Trump Trade Reversal: The market's initial anticipation of pro-growth policies and inflation following the 2024 US election, which led to a dollar surge, later reversed.
AI Enthusiasm: The driving force behind the current stock market rally, fueled by significant corporate capital expenditures in artificial intelligence.
Safe Haven Assets: Assets that investors flock to during times of economic uncertainty, such as gold and, historically, the US dollar.
Currency Diversification: The strategy of holding assets denominated in different currencies to mitigate risks associated with fluctuations in any single currency.
US Exceptionalism: The historical dominance of US companies and markets in global equity performance.
Emerging Market Debt: A niche fixed-income asset class that offers high yields and potential for capital appreciation, often correlated with equities.
Earnings Season: The period each quarter when companies report their financial results and future forecasts.
Short-termism vs. Long-termism: The tendency for investors to focus on immediate market movements versus maintaining a long-term investment perspective.
Bifurcated Market Views: The current market environment characterized by extreme optimism for AI-related companies and pessimism for others.

The Weakening Dollar and Its Impact on Portfolios

The first half of 2025 saw a significant decline in the US dollar, making it a challenging period for portfolios. While the dollar has shown some recovery, it remains below its starting point for the year. This weakening has led to stronger performance for currencies like the euro, Japanese yen, and Mexican peso against the US dollar. Several factors are influencing the dollar's future trajectory, and its performance has direct implications for everyday investors.

Factors Influencing the Dollar's Performance

1. Post-Election Reversal (The "Trump Trade"):

Following the US election in November 2024, the dollar initially surged due to market anticipation of pro-growth policies, increased spending, potential inflation, and higher interest rates for an extended period.
However, this "Trump trade" reversed in 2025, indicating that the market's initial assessment may have been incorrect.

2. Concerns and Tensions:

Tariffs: The implementation of tariffs has unsettled market participants and contributed to dollar weakness.
Debt and Deficit: Growing concerns about the US national debt and budget deficit are also weighing on the dollar.
White House and Federal Reserve Tension: Disagreements or perceived tension between the executive branch and the Federal Reserve can create uncertainty.

3. Historical Performance:

The first half of 2025 marked the dollar's worst performance in the first half of any year since 1973, with a sharp fall against major trading partners.

The Stock Market's Resilience Amidst Macroeconomic Headwinds

Despite the weakening dollar and other macroeconomic concerns, the stock market has shown remarkable strength.

1. Market Wobble and Rebound:

The US stock market experienced a downturn between late February and early April 2025, with the "liberation day tariff turmoil" causing it to flirt with bear market territory.
However, the market has since rebounded, logging significant year-to-date gains.

2. AI Enthusiasm as a Driving Force:

The primary driver of the stock market's ascent is the widespread enthusiasm surrounding Artificial Intelligence (AI).
Hundreds of billions of dollars in corporate capital expenditures (capex) are being directed towards AI development.
This has boosted the earnings of companies involved in chip manufacturing, data centers, and cloud storage.

3. Market Tension: Greed vs. Fear:

A significant tension exists in financial markets between bullish (greed) and bearish (fear) sentiments.
The stock market is reflecting bullishness driven by AI, while bearishness and fear are more evident in the currency markets.

Bond Market Performance and Economic Slowdown Fears

The bond market is also reflecting concerns about economic slowdown.

1. Interest Rate Cuts and Weakened Job Market:

Interest rate cuts in 2025 and a weakening job market have contributed to a more cautious outlook.

2. "Trump Trade" Reversal in Bonds:

Similar to the dollar, bond yields initially surged after the election on expectations of inflation.
However, yields have since come down significantly. The 10-year Treasury yield fell below 4% in October.
This movement suggests that fear and concerns about economic slowdown are manifesting in the bond market.

Gold's Rise as a Safe Haven Asset

Gold has outperformed the US dollar as a safe haven asset in 2025.

1. Dollar's Historical Safe Haven Status:

Historically, the US dollar has benefited from "flight to safety" during crises, appreciating during events like the 2008 financial crisis and the COVID-19 pandemic.

2. Central Banks Shifting to Gold:

Global central banks have been moving out of the dollar and into gold as a reserve asset.

3. Reasons for Diversification Away from the Dollar:

US Debt: The US national debt is approaching 120% of GDP, raising institutional concerns.
Tariff Policy: Uncertainty surrounding trade policies.
Geopolitics: The Russian invasion of Ukraine and the subsequent freezing of Russian assets led to concerns about the "weaponization of the dollar," prompting governments to diversify.

4. Gold as a Store of Value:

Despite being considered an "unproductive asset" by some skeptics due to its lack of cash flows, gold is perceived as a reliable store of value with a long history.

International Stocks Outperforming US Stocks

International stocks have shown stronger performance than US stocks in 2025, partly due to currency effects.

1. Currency Amplification of Gains:

For US investors holding unhedged international shares, appreciating foreign currencies have amplified the gains from international markets.
The MSCI World ex USA Index has outperformed the US market index by over 12 percentage points year-to-date.

2. Case for Increasing Overseas Exposure:

US Exceptionalism Ending: The long period of US market dominance, driven by large-cap tech companies (e.g., the "Magnificent 7"), may be waning.
Market Cap Discrepancy: The US share of global equity market value (over 62%) is significantly disproportionate to its share of the global economy (about 25%).
Full Spectrum of Opportunity: Investing globally opens portfolios to a wider range of companies with strong economic moats and durable competitive advantages. Examples include European pharmaceuticals, Japanese electronics manufacturers, Mexican airports, and AI supply chain nodes like Taiwan Semiconductor and ASML.
Currency Diversification: A key argument for global investing is to hedge against currency fluctuations.

Emerging Market Debt: An Attractive Niche

Emerging market debt has also benefited from dollar depreciation and is considered an attractive asset class.

1. Characteristics of Emerging Market Debt:

High Correlation with Equities: Unlike traditional fixed income, emerging market debt is highly correlated with equities.
Credit Risk: It carries significant credit risk.
High Yields and Capital Appreciation Potential: As a result of credit risk, it offers high yields and the potential for capital appreciation.

2. Performance:

The emerging markets bond index is up over 10% this year, benefiting from dollar depreciation, whether in US dollar-denominated or local currency bonds.

Risks to Dollar Dominance and Investor Strategies

While the dollar's status as the global reserve currency is being questioned, its dominance is not immediately at risk.

1. Factors Affecting Dollar Dominance:

Morningstar Investment Management analysis considers fiscal balance, trade balance, institutions, and geopolitics.
Despite this year's depreciation, the dollar is still considered overvalued.

2. Why Everyday Investors Should Care About the Dollar:

Impact on Investment Returns: Currency dynamics can significantly affect investment returns, as seen in 2025.
Long-Term Currency Effects: While currency effects tend to "come out in the wash" over very long periods, severe currency debasement in some countries has wiped out investors.
Mitigating Risk: Global exposure and currency diversification can benefit investors, especially in scenarios of significant currency debasement.

3. Hedging Bets and Currency Diversification:

Cyclical Nature of Currencies: Currencies, like all market segments, go through cycles.
Benefits of Foreign Currency Exposure: Periods of dollar weakness have historically benefited US investors with foreign currency exposure.
Recommendation: It is advisable to incorporate some level of currency diversification into portfolios to hedge bets.

Earnings Season and Market Outlook with Dan Kemp

Dan Kemp, Chief Research and Investment Officer at Morningstar Investment Management Europe, discusses earnings season and the broader market sentiment.

Navigating Earnings Season

Importance of Earnings: Earnings are crucial for understanding company management's decisions and performance.
Short-Term Focus Risk: Earnings season occurs quarterly and tends to be short-term oriented, which can encourage investors to adopt a short-term perspective.
Long-Term Orientation: True investing is long-term. Investors should not use earnings season to shorten their time horizon.
Investment Decision Framework: If considering buying a stock during earnings season, investors should be prepared to own it for at least five years, assuming nothing fundamental changes. The same applies to selling decisions.

Tesla and Bifurcated Market Views

Optimism for AI Leaders: Companies perceived as leaders in the AI space often have significant optimism baked into their share prices.
Tesla as an Example: A substantial portion of Tesla's valuation is attributed to unproven future products like humanoid robots, AI testing, and self-driving cars.
Pessimism in Other Market Segments: Conversely, parts of the market not involved in AI face considerable pessimism.
Investment Opportunities: The best investment opportunities often lie in the undervalued and "unloved" segments of the market, rather than following the crowd of optimists.

Upcoming Market Events and Investor Focus

Federal Reserve Interest Rate Announcement: A quarter-point rate cut is widely expected. Investors will closely monitor Fed Chairman Powell's press conference for forward guidance.
MAG 7 Earnings: Five of the "Magnificent 7" tech companies are reporting earnings this week. These companies represent over 20% of the broad market, and their results will provide insights into the future of technology and the broader market.
Long-Term Perspective Reminder: Investors are advised to avoid excessive focus on short-term market movements and maintain a long-term perspective aligned with their financial goals.

Conclusion

The weakening dollar in 2025 has highlighted the interconnectedness of global markets and the importance of currency diversification for investors. While AI enthusiasm is driving the stock market, concerns about economic slowdown are evident in the bond market, and gold has emerged as a strong safe haven. International stocks are outperforming US stocks, partly due to currency tailwinds, and emerging market debt offers attractive yields. Investors are encouraged to maintain a long-term perspective, consider global diversification, and be mindful of the potential impact of currency fluctuations on their portfolios.