The strong dollar is hindering growth in US equities this year, analysts are warning. The US dollar has been persistently strong in the last year, and has risen around 18 per cent on a trade weighted basis against a basket of other currencies in 12 months. It has continued to strengthen throughout this year, and is up five per cent since 13 May.
The currency has strengthened as investors continue to see the US as a safe haven, with strong growth and a robust economy that will be the scene of interest rate hikes which the market is expecting some time this autumn.
But at the same time, currency strength appears to be hindering the stock market, as the S&P 500 has failed to make new headway this year.
The index is struggling to hold a one per cent gain year to date.
“Admittedly, the value of the stock market depends on myriad factors. But it is not surprising that the dollar’s renewed vigour has weighed on this index, given the global reach of the multinational companies of which it is comprised,” says John Higgins of Capital Economics.
Investors fear this renewed dollar strength is limiting corporate profitability.
When this current reporting season is over, it looks as though Eurozone companies will have overtaken US corporates in earnings growth for the first time since the financial crisis.
The S&P 500 is very reliant on overseas earnings, and when those revenues are translated back into dollars, the relative strength of the greenback will make for an unflattering effect.
“The issue with the strong dollar comes down to corporate profitability. US companies’ exports are more expensive and therefore less competitive. That has put pressure on corporate earnings,” explains Adrian Lowcock of Axa Wealth.
Dollar strength is putting more pressure on an equity market already trading around record highs.
“Valuations are high, not outrageously so, but it is high. Why would the US market continue to rally?” adds Lowcock.
The situation is little better on the small cap market, where corporate revenues are more domestically orientated. The Russell 2000 is behind the S&P 500 so far this year.
“Many investors have been favouring small-cap stocks, which depend less on international sales than larger companies, in an effort to mitigate the impact of a stronger dollar,” says Russ Koesterich at BlackRock.
“But the strategy has not provided much benefit.”
He surmises that investors have shied away from smaller US companies because they are more exposed to the rate rises.
Therein lies the conundrum. The economy is ready for rate rises because it has returned to health, but this is attracting investors to the dollar and having the knock-on effect of limiting stock market growth. Some economists expect further dollar strength to come.
“The rally in the dollar is not over given the prospects for monetary policy in the US where we expect the key policy rate to be raised further and faster than the markets expect,” says Higgins.