Welcome to RBC’s Markets in Motion podcast, recorded March 31st, 2021. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
This week in the podcast, we tackle the topic of the US Dollar, and what it’s recent strengthening means for the US equity market.
The consensus view coming into 2021 was for the US Dollar to weaken. If you look at CFTC data on buy-side FX positioning, it shows a fairly deep US Dollar short in place, though that is starting to reverse.
The big thing you need to know: A stronger Dollar is mostly a negative for the US equity market in terms of performance, earnings revisions, and margins. But sector impacts aren’t uniform, and it’s a challenge for the stock market that should be thought of as looming in the distance rather than one that’s likely to hit stocks imminently.
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Let’s jump into the details:
First, the stronger US Dollar’s overall impact on US equities.
- In terms of performance, when the dollar is strengthening, US equities tend to outperform their non-US developed markets peers as well as emerging markets.
- But the more important thing for US focused investors to be aware of is that when the US Dollar is strengthening year over year, the S&P 500 also tends to be lower year over year. In other words, a stronger Dollar is typically associated with a risk off tone to stocks.
- In terms of earnings revisions, when the US Dollar strengthens year over year, we tend to see downward EPS estimate revisions for the S&P 500 at the broader index level, as well as most of its sectors.
- In terms of margins, we tend to see an inverse relationship between a stronger dollar and EBIT margin trends for both the S&P 500. Dollar strengthening, in other words, tends to pressure margins.
- This phenomenon isn’t limited to the S&P 500 Large Caps. Takeaways are similar for the Russell 2000 Small Caps.
Moving on to sector sensitivities.
- What’s particularly interesting about our analysis of the sensitivity of sector level EPS revisions trends to US dollar trends is where the sensitivities are most extreme.
- Within the S&P 500, the inverse correlations are most powerful for Energy, Industrials, and Materials (key parts of the cyclical Value trade), followed by Consumer Staples, Tech, and Health Care (key parts of the classical defense and secular growth trades).
- Sectors whose EPS estimate revisions trends have the lowest correlations with US Dollar trends include REITs, Utilities, Consumer Discretionary, and Financials (a mix of classic defense and cyclicals).
- Takeaways are also very similar for the Russell 2000 Small Cap sectors.
- The overarching takeaway here is that a stronger Dollar is a negative development for the reflation trade, but some parts (the commodity sectors and Industrials) are more negatively affected than others (like Financials), and the Growth trade (specifically Tech and Health Care) is not immune.
Wrapping up with timing – we view the stronger US dollar as a looming headwind for US stocks, but think it’s a little too early for investors to get too worked up.
- Historically, when we look at performance, revisions, margins, what really matters is when the US Dollar starts to strengthen year over year, which it’s at risk of doing in 3Q if it moves up a little bit more from current levels.
- In terms of what companies are saying today, there hasn’t been too much discussion of the US dollar or FX generally on recent earnings calls. But among those who have discussed it, FX is still generally being described as favorable
That’s all for now. Thanks for listening. Please reach out to your RBC representative with any questions.