Analysts are ringing alarm bells over a surge by the U.S. dollar, warning it may be set to serve as another “headwind” for U.S. stocks as they struggle through a losing September.
“Since early August, the USD (U.S. dollar) has climbed above its average [second-quarter] level. That means that for corporates, the USD switched back from tailwind to headwind…and an increasing one” as investors close out the third quarter this week, said Andrew Greenebaum of Jefferies, in a Saturday note.
A rapidly strengthening dollar is often seen as a problem for big, U.S. multinationals. A stronger dollar makes their goods more expensive to overseas buyers. And income earned overseas will be less valuable on their income statements.
The U.S. dollar went on a tear in 2022 as Treasury yields surged in response to the Federal Reserve’s aggressive series of interest-rate hikes. The ICE U.S. Dollar Index
DXY,
a measure of the currency against a basket of six major rivals, hit a 20-year high last September, but then retreated sharply.
The pullback, which saw the index drop from a high near 115 last fall to a low below 100 in July, was seen as a tailwind for stocks. The S&P 500
SPX
saw its bear-market bottom in October of last year, and built on its rally through the winter and spring. Since late July, stocks have suffered a pullback, with the large-cap benchmark down around 5.5% from its 2023 high set on July 31.
“After creating a substantial headwind to profits for U.S. multinationals, it’s been a tailwind [year to date]. But that all changed roughly 10 weeks ago,” Greenebaum wrote.
The DXY has ripped higher by around 4% in that short time frame, a move more than one standard deviation outside the norm, he noted. And that sort of move has tended have implications for both company fundamentals and asset allocation.
The chart above breaks out the average performance of key indexes, including the S&P 500, S&P 500 cyclicals, small-caps (RTY), the Nasdaq-100
NDX
and the MSCI All-World excluding U.S.
Small-caps are typically expected to outperform during periods of dollar strength, since most of their revenues come from within the U.S. Cyclical stocks are expected to suffer.
A rising dollar also tightens financial conditions, adding to other headwinds for stocks heading into the fourth quarter, said analysts at Morgan Stanley, in a Monday note (see chart below).
“With the 10-year real rate at a 16-year high above 2.0%, the U.S. dollar is surging, producing meaningful headwinds for U.S. multinationals,” they wrote.
“Oil is becoming a constraint as well, with West Texas Intermediate crude
CL00,
up more than 30% from its spring trough. Together with indications that bank lending and credit availability are already shrinking, these factors suggest the liquidity backdrop may worsen,” they wrote.
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