And while that may favor U.S. large-cap stocks (NYSEARCA:SPY) (QQQ) (DIA) on the global stage, it will also have an impact on earnings. With roughly 30% of revenues for U.S. companies generated overseas, according to Goldman Sachs, the "strong dollar" may replace "supply chain issues" as the go-to excluse for missing consensus estimates.
"A stronger USD has been historically correlated with a lower frequency of sales beats," Goldman Sachs equity strategist David Kostin wrote in a note.
"The implied relationship between dollar strength and top-line results suggests that fewer S&P 500 (SP500) (SPY) firms will beat consensus sales forecasts in 3Q compared with 49% in 1Q and 45% in 2Q 2022," he added.
Looking to the bottom line, a strong dollar tends to hit EPS further down the road, Citi said.
"Long-term correlations imply a rising dollar has a lagged impact on earnings of 3-6 months," Citi equity strategist Scott Chronert said. "The +11% rise in the trade weighted dollar in the past year could hit early 2023 index level earnings by -$15-20. This is well recognized in our 2023 S&P 500 EPS estimate of $215, but not in bottom-up consensus of $239."
"The strong US dollar can serve as a double-edged sword," Oppenheimer strategist Johns Stoltzfus said. "The currency’s strength offsets inflation in the US by reducing the cost of imported consumer goods at a time when consumer demand is strong."
"However, a higher dollar can create headwinds that can make US products and services less competitive overseas and negatively impact earnings of US multinational companies," he said. "For US investors looking to diversify their portfolio exposure into foreign markets dollar strength proffers the opportunity to pick up foreign asset exposure 'on the cheap.'"
If the dollar retreats, the benefits to the S&P 500 may not be as strong as the detriments of a rising greenback, Citi's Chronert said.
"Lower correlation and beta to a high but falling dollar implies that the S&P 500 may not benefit as aggressively if the greenback trend reverses," he said. "Essentially, upside from a weaker dollar may not match the pain felt from a rising dollar."
"Historically, it is more likely that a rising dollar will benefit Growth (IWF) over Value (IWD)," he added. "That is not the case of late as investors worry over dollar sensitives to Consumer Discretionary (XLY) and Information Technology (XLK) (which are heavy Growth weights). This relationship could change and turn more positive as further dollar strength likely signals more severe global growth fears, making the less traditionally economic sensitive Growth sectors more attractive again."
"Small Cap (IWM) relative to Large (IWB) is likely most misunderstood. Many believe that a strong dollar should benefit the more domestically oriented Small Caps. However, the relative performance correlation over time implies a weaker dollar tends to be better for the small size trade."
Focus on domestic sales
"Continued USD strength would support the performance of stocks with 100% domestic sales relative to those with a higher proportion of foreign sales," Kostin said.
"Since July, consensus has trimmed 3Q EPS for the median constituent of our Domestic Sales basket by 1% and left 2023 estimates unchanged," he said. "In contrast, 3Q EPS for the median International Sales basket constituent with 73% nonUS sales has been cut by 4% and 2023 estimates have reduced by 3%."
"The median (domestic) stock trades at a 12% P/E discount to the median (international) stock (vs. a long-term average of 5%) and offers slightly faster 2023 EPS and sales growth."
The stocks in the Goldman Sachs Domestic Sales basket by sector are:
- Communication Services (XLC), % of non-U.S. sales sector median = 37%
- Charter Communications (CHTR), non-U.S. sales 0%
- Fox (FOXA), 0%
- T-Mobile (TMUS), 0%
- Verizon Communications (VZ), 0%
- Dish Network (DISH), 0%
- Consumer Discretionary (XLY), median = 21%
- Dollar General (DG), 0%
- Chipotle (CMG), 0%
- Ross Stores (ROST), 0%
- Target (TGT), 0%
- D.R. Horton (DHI), 0%
- Consumer Staples (XLP), median 27%
- Energy (XLE), median 16%
- Financials (XLF), median 7%
- Truist Financial (TFC), 0%
- CME Group (CME), 0%
- Charles Schwab (SCHW), 0%
- PNC Financials (PNC), 0%
- Capital One (COF), 0%
- Wells Fargo (WFC), 0%
- Healthcare (XLV), median 39%
- Elevance Health (ELV), 0%
- Centene (CNC), 0%
- AmerisourceBergen (ABC), 0%
- Quest Diagnostics (DGX), 0%
- CVS (CVS), 0%
- Humana (HUM), 0%
- DaVita (DVA), 6%
- Industrials (XLI), 31%
- Info Tech (XLK), median 54%
- Paycom (PAYC), 0%
- Tyler Technologies (TYL), 0%
- Jack Henry (JKHY), 0%
- Paychex (PAYX), 1%
- Intuit (INTU), 5%
- CDW (CDW), 12%
- Broadridge Financial (BR), 12%
- ADP (ADP), 13%
- Fiserv (FISV), 14%
- Enphase Energy (ENPH), 20%
- Global Payments (GPN), 21%
- Roper Technologies (ROP), 22%
- Fidelity National Info (FIS), 26%
- Cognizant Tech (CTSH), 26%