The Dollar, Long & Short
We’re dedicating today’s entire Data section to the value of the dollar and how this translates to US corporate earnings fundamentals. We use the Federal Reserve’s Trade Weighted Dollar Index rather than the DXY because it includes a broader and more representative basket of currencies. DXY doesn’t even have the Chinese yuan or the Mexican peso.
Three points on this topic:
#1: A long run look at the Trade Weighted Dollar Index (chart below, 2004 – present) shows how global currency markets trade through a cycle.
Global recessions/crises create safe-haven demand for the dollar. This is plainly visible in the 2008 – 2009 recession (dollar peak in March 2009, right as global equity markets troughed) and again in March 2020 (again at a low for global equities).
Now, looking across cycles (2006 – 2021); the dollar has clearly traded like a secular growth vehicle. It has, for example, appreciated 28 percent over the last decade. That is an annual compounded growth rate of 2.5 percent. Across the entire timeframe pictured here, the dollar is up 11.6 percent, for a 0.7 percent CAGR. Over the same timeframes, the euro is exactly flat to the dollar since 2006 and down 15 percent over the last decade, just to call out one major non-dollar global currency.
Takeaway: whenever you hear that the dollar is about to lose its reserve currency status or otherwise implode, remember this chart. No one would call the last 16 years the most stable or predictable in America’s history. But the dollar has done just fine. In short, if there’s a crack forming in the dollar’s secular, long run appeal we just don’t see it in this chart.
#2: The chart above also shows that global economic recoveries do see the dollar decline as capital goes off looking for better returns outside the US but this is a multiyear process, and the greenback can stage rallies over that time.
We’ve highlighted one such event, boxed in the chart above. After the dollar weakened from March through December 2009 by 12.3 percent, it rallied by 5 percent through the first half of 2010. The eventual 2010s low was July 2011, 19.0 percent below the March 2009 highs.
We’re seeing the same sort of action right now. The dollar weakened by 11.8 percent from the March 2020 high through year end; that’s eerily close to the 12.3 percent 2010 drop noted above. Now, it’s been rallying since January 5th, 2021 and is up 1.8 percent from then. It should surprise no one if it adds another 3 percent in Trade Weighted Value Index terms, matching the 2010 move.
Takeaway: just as in 2010, markets are reevaluating the pace of non-US global economic recovery. No other major country is spending what the US is shelling out to recover from the pandemic, and America’s vaccine rollout has been solid. A further move higher for the dollar in coming weeks would be logical.
#3: The value of the dollar over time has dramatically different P&L effects on various S&P sectors, as this FactSet chart of non-dollar revenues by industry shows. The S&P 500, as a whole, derives 40 percent of its revenues from non-dollar markets.
As you can see, Tech (57 pct non-US sales) is the most exposed to dollar strength potentially hurting marginal profits, with Materials (55 pct), Consumer Staples (44 pct) and Communication Services (41 pct, mostly thanks to Google and Facebook) also above 40 percent. Yes, Energy is at 42 percent but oil is priced in dollars, so its situation is somewhat different.
Also worth noting: Financials and Industrials have lower-than-average non-US revenue exposure despite their reputations as global industries.
Takeaway: if our idea that the dollar is in for a bout of relative strength as in 2010, Tech could see some near-term weakness. It’s not so much that markets care about the incremental margin from currency conversion; they really don’t. It’s more that a temporarily stronger dollar means all’s not right with non-US growth. Given these companies’ very global footprints that is a marginal negative about their aggregate earnings leverage in 1H 2021.
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Tue, 03/23/2021 – 14:20