The dollar's bullish sentiment continues to thrive, and as we move forward, the first group of "victims" of a stronger dollar is poised to appearSince the beginning of the year, the dollar has experienced robust appreciation, a trend that could put corporate profitability to the testThis week, prominent banks and retail corporations are set to release their earnings, marking the early stages of what many are calling a revealing earnings season.
According to Mike Wilson, an analyst at Morgan Stanley, the ascent of the dollar may exacerbate the typical discrepancies in earnings per share (EPS) revisions that frequently occur during earnings seasonsIn simpler terms, as the dollar maintains its strengthening streak, companies heavily invested in international markets may face mounting challengesConsumer goods and home products companies serve as prime examples of those affected; these corporations often operate globally, conducting production and sales across numerous regions
When the dollar surges, the profits earned abroad, when converted back to dollars, may suffer significant discountingThus, despite a potential rise in actual sales, the adverse effects of currency fluctuations can slow profit growth when framed in dollar terms.
Wilson elaborates that this situation is likely to create a broader array of performance outcomes among individual stocks during earnings seasonUnder these circumstances, selecting high-performing stocks could prove even more crucial and effectiveOn the index level, EPS growth is expected to linger in the single digits, reflecting the complexities of the current economic landscape.
Data from FactSet underscores that in the third quarter of last year, S&P 500 companies with international business exposure were instrumental in driving profit growth, capturing a large share of overall earningsNonetheless, there looms a grim possibility: even minor fluctuations in the foreign exchange market, particularly a weakening of currencies, could drastically influence the broader stock market's trajectory
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Currency depreciation can lead these multinational corporations to experience exchange rate losses when reconciling overseas business transactions and repatriating profits, undermining their profitability and investor confidence, ultimately impacting the entire stock market.
The bullish movement of the dollar can primarily be attributed to robust economic indicators triggering a reevaluation of future monetary policy by the Federal ReserveSince reaching a low last September, the dollar index, which measures the value of the dollar against a basket of six foreign currencies (the euro, yen, British pound, Canadian dollar, Swedish krona, and Swiss franc), has soared by 10%. Wilson notes that, given these dynamics, we should anticipate an uptick in mentions of currency impacts during this earnings season.
Proposed policies—such as imposing steep tariffs on imported goods, instituting tax cuts for businesses, and restricting immigration—are contributing to this bullish dollar sentiment due to their inherently protectionist nature
Moreover, most economists are in agreement that these initiatives (particularly the tariff schemes) could eventually catalyze heightened inflation, compelling the Federal Reserve to sustain elevated interest rates over an extended periodAs a result, the cycle of optimism surrounding the dollar remains intact.
A research team at Goldman Sachs, led by analyst Kamakshya Trivedi, mentioned in a separate report last Friday, "Looking ahead, the key question remains how much the changes in the dollar index will be confirmed by the data soon to be released and whether these movements have already accounted for our expectations regarding the new government's policy shifts, especially concerning higher tariffs." The team predicts a further appreciation of around 5% for the dollar in the upcoming year, noting that the upward risks have not been fully priced in.
Goldman Sachs acknowledges, "We concede that forex market participants are clearly pricing in some level of tariff policy adjustment, and it has been challenging recently to distinguish the factors propelling the dollar's movement
Nonetheless, we still believe that there is further room for the dollar to appreciate."
Considering the expectation of a stronger dollar on the horizon, Wilson from Morgan Stanley argues that the profitability momentum for consumer goods companies seems "less robust" and adds that tariff risks continue to remain an unresolved issue for valuationsHe expresses a more optimistic perspective regarding service sectors, indicating that profit expectations in tourism, leisure, media, and experiential industries are on the upswing.
Despite these challenges, multinational corporations may still announce strong earnings reports based on domestic demand, even amidst currency impactsUnder such circumstances, U.Sstocks could continue to perform well.
"As long as robust domestic growth is the primary driver of the dollar's appreciation, the performance of the S&P 500 index can remain quite resilient during periods of dollar strength," Wilson states