By Anneken Tappe
The U.S. dollar has been on a nearly unstoppable uptrend since
the start of the second quarter, rising in tandem with government
bond yields, while equities got the short end of the stick.
Now, investors wonder whether a buoyant buck will derail
earnings growth.
Since the beginning of April, the ICE U.S. Dollar Index , a
popular gauge of the U.S. currency that measures it against six
rivals, is up 3.9%. Meanwhile, the S&P 500 was off 0.3% and the
Nasdaq Composite Index was down 0.4% over the same period, marking
just past the halfway point for the second quarter.
Don't miss:Bonds, stocks and gold all falling at the same time
meant there was almost nowhere to hide
(http://www.marketwatch.com/story/bonds-stocks-and-gold-all-falling-at-the-same-time-means-there-is-almost-nowhere-to-hide-2018-05-15)
The Dow Jones Industrial Average was up 2.5% over the same
period, according to FactSet data.
So what gives?
"The lackluster year-to-date performance of equities suggest
that strong first quarter results are arguably already reflected in
current prices," Terry Sandven, chief strategist at U.S. Bank
Wealth Management told MarketWatch in emailed comments. "Among the
factors that could temper the pace of earnings growth is a rising
dollar."
The stock market has been troubled by the greenback's rally,
which has in part been thrust higher by rising yields on U.S.
government bonds. Those, in turn, represent higher expected
interest rates that can be unfavorable to stocks.
Don't miss: Just 1% of investors expect the economy will be
stronger a year from now
(http://www.marketwatch.com/story/just-1-of-investors-expect-the-economy-will-be-stronger-a-year-from-now-2018-05-15)
In the past week, the 10-year Treasury yield rose back above the
3% threshold to hit a seven-year high, leading the dollar higher
and causing bouts of pain for equities. The Dow and the Nasdaq
faced their biggest daily percentage slump in three weeks
(http://www.marketwatch.com/story/dows-8-session-win-streak-in-jeopardy-as-us-stock-futures-dip-2018-05-15).
For the S&P it was the worst daily performance since the
beginning of the month.
Rising interest rates suggest higher borrowing costs and rising
valuations for companies, which is weighing on stocks.
Also check out:Here are the 20 stocks that the biggest hedge
funds love most
(http://www.marketwatch.com/story/here-are-the-stocks-that-hedge-funds-love-most-2018-05-17)
In the week ahead, the Federal Reserve will release the minutes
from its May 1-2 meeting, which could add to the dollar and
Treasury yield climb should they sound a hawkish tone. There was no
news conference for the Fed's May meeting, a point that confers
more significance on the minutes.
See:Fed is 'one decision away' from hammering Treasurys, says
bond fund manager
(http://www.marketwatch.com/story/fed-is-one-decision-away-from-hammering-treasurys-says-bond-fund-manager-2018-05-17)
"With inflationary pressures being more prevalent, interest
rates in the U.S. being on the cusp of a regime change, and apace
of global growth appearing less synchronized, conditions are ripe
for the U.S. dollar to inch higher in the second half of 2018,"
Sandven said. "A rising dollar is a headwind to earnings growth and
valuations, suggesting that future equity returns are apt to be
more subdued."
The S&P 500, for example, has material exposure to foreign
economies and thus their currencies and the inherent currency risk.
Companies with foreign earnings are exposed to the exchange rate
risk between the U.S. and other countries they're active in. If the
dollar is weak, currencies abroad other foreign currencies perform
better and boost earnings abroad for U.S. businesses.
Just like a weak buck led multinational S&P 500 constituents
to outperform due to stronger currencies elsewhere in the first
quarter
(http://www.marketwatch.com/story/how-much-the-weak-dollar-lifted-q1-earnings-for-multinationals-ameriprise-2018-05-17)
of the year, the dollar's newfound strength may have the reverse
effect on second-quarter earnings.
Read:Here's the mood in the boardroom after a stellar earnings
season
(http://www.marketwatch.com/story/corporate-executives-are-feeling-good-about-the-economy-and-trade-policy-but-are-seeing-inflation-creep-up-2018-05-18)
Inherently global sectors, such as materials, financials and
energy, tend to suffer particularly from a rising greenback,
according to data from S&P Global.
The energy sector, for example, is "too sensitive to the
downward pressure on oil with a strengthening dollar," wrote Jodie
Gunzberg, managing director and head of U.S. equities at S&P
Dow Jones Indices in a blog post
(http://www.indexologyblog.com/2018/05/13/heres-how-a-rising-dollar-impacts-stocks/).
That said, there is more to the link between the dollar and the
energy sector, in particular when it comes to oil, in part because
the U.S. is now a net producer of the commodity.
See:Oil and the dollar are doing something they have only done
11 times in the past 35 years
(http://www.marketwatch.com/story/oil-and-the-dollar-are-doing-something-they-have-only-done-11-times-in-the-past-35-years-2018-05-09)
Oil futures hit 3 1/2-year highs in the past week, with Brent
crude , the global benchmark temporarily trading above the
psychologically important $80 level on Thursday.
Check out:Here's what surging oil prices mean for the stock
market
(http://www.marketwatch.com/story/heres-what-surging-oil-prices-mean-for-the-stock-market-2018-05-18)
And history offers some comfort. Close to 71% of revenues of
S&P 500 companies are generated in the U.S., and looking at the
past decade, a rising dollar hasn't dragged them down.
Read:Why it may be downhill from here for the U.S. dollar
(http://www.marketwatch.com/story/it-may-be-downhill-from-here-for-the-us-dollar-2018-05-14)
Since 2008, the data show, for every 1% rise in the dollar
large-cap companies have gained 71 basis points on average, thanks
to their heavier U.S. revenue concentration. Especially consumer
staples, health care and utilities were helped by the strong
buck.
For midcap and small-cap firms the correlation was even
stronger, as those companies tend to generate even more of their
revenues in the U.S., on average. And indeed, in the year-to-date
small and midcaps have been outperforming, as evidenced by the
performance of one measure of small-cap names, the Russel 2000 ,
which has gained 5.9% so far this year and is up 6.3% since the
beginning of April.
See:Here's why small-cap stocks can continue to beat their
large-cap peers
(http://www.marketwatch.com/story/heres-why-small-cap-stocks-can-continue-to-beat-their-large-cap-peers-2018-05-18)
Looking ahead
On the data front, the week ahead starts with the Chicago Fed
National Activity Index on Monday. Besides the FOMC minutes, the
composite flash PMI for May is also due on Wednesday, before weekly
jobless claims and home sales data on Thursday. Consumer sentiment
and durable goods orders conclude the data run on Friday.
Among Fed speakers, Fed Chairman Jerome Powell is scheduled to
address an event in Stockholm on Friday morning Eastern Time.
Ahead of Powell's speech, investors will hear from Atlanta Fed
President Raphael Bostic, Philadelphia Fed President Patrick Harker
and Minneapolis Fed President Neel Kashkari on Monday. Harker will
speak at a second event on Thursday, with New York Fed President
William Dudley also set to deliver remarks that day.
Following Powell's speech on Friday, Chicago Fed President
Charles Evans and Dallas Fed President Rob Kaplan are scheduled to
appear on a panel together and Bostic delivers another speech.
(END) Dow Jones Newswires
May 20, 2018 16:56 ET (20:56 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.