Investment Implications of a Stronger $
earnings, and profound impacts on oil and commodity prices
Dollar cycles impact equity multiples because they reflect and drive capital flows. Dollar cycles impact earnings through a complex variety of channels encompassing both top line and margins, but go well beyond the obvious translation impacts on foreign earnings and competitiveness. The dollar is a key driver of oil and commodity prices with a higher dollar negative for prices.
With the dollar's current up cycle still in its early stages, we see significant divergences in regional equity market, sector and individual
stock performance for some time to come. Key top-down strategic themes are:
Multiple over earnings: overweight the US on prospective capital inflows;
Regionally, long commodity importers and short commodity exporters;
Overweight the drivers (growth and rates) of the US dollar up cycle; US financials benefit, bond-like payout sectors Telecoms and Utilities lose;
Underweight Energy and Materials.
There are several common themes in company analyst views on the impact of a higher dollar on industries and individual stocks:
Higher USD revenue and assets are positive, higher USD costs and liabilities are negative; Japanese companies in most sectors benefit disproportionately given their export focus, while global European companies also benefit as most have large US operations;
FX market hedging practices vary widely across industries and firms;
Cost and revenue impacts go beyond the direct translation/ competitiveness effects; such as for US retail;
Market structure will determine whether FX changes are passed on or accrue to margins; oligopolistic markets likely to see benefits to margins;
FX exposure of the industry and not just the individual company matters as currency moves realign competitor cost advantages;
EM banks negatively exposed to tightening local liquidity;
Strategic implications (cross border M&A; cash repatriation; on versus offshoring) likely to be mixed.
Eoin Treacy's view It has been quite some time since a Dollar
bull market has been a realistic consideration. At present the Dollar is a favoured
currency by process of elimination rather than a compelling bullish theme. For
example, the devaluation of the Yen and the associated pressure this puts on
other Asian currencies, continued stress on the European economy and the weakness
of commodity investment for the Australian Dollar, Canadian Dollar and other
commodity related currencies leaves the US Dollar as one of the few relatively
The Dollar Index has rallied from the lower side of its base formation since 2011 but remains squarely within that base formation despite recent strength. For a convincing bull market story to justify Dollar strength, independent of weakness in other currencies a confluence of positive events will be required. Quantitative easing will need to be tapered and eventually ended without stoking inflation. A return to self-sustaining growth is likely before this can be accomplished. In order to support growth, the USA's competitive advantages in energy (particularly natural gas) and technological innovation will need to be leveraged to enhance productivity. These could all be considered major achievements but the timeframe for such a benign scenario is in terms of years instead of months. At the very minimum, the Index will need to hold its two-year progression of higher reaction lows if this bullish opinion is to remain credible.
By the time we have technical confirmation of a new bull market for the US Dollar it will have strengthened considerably from where it trades today. With that in mind, the relative strength of assets that should perform well in a strong Dollar environment such as the US banks, industrials, chemicals and consumer sectors, Europe and Japan's export sectors are all supportive of the bullish case. It should also be noted that following a strong performance so far this month, a number of US sectors are overbought and the technology sector in particular has been pulling back in a process of mean reversion.