The Mnuchin Weak Dollar Policy

“A strong dollar is in the long term best interests of the US.” Those simple words are something called the “Rubin doctrine”, after 1990s Treasury Secretary Bob Rubin. Most of his successors have held to that basic message, although in practice it has made little difference to the value of the greenback over the long term. Fundamentals always win in the end, after all.

“Obviously a weaker dollar is good for us as it related to trade and opportunities.” You can call that the “Mnuchin doctrine”, for that is what the current Treasury chief said in Davos today. While giving a nod the signaling effect of a strong dollar validating its reserve currency status over the long term, he said near term swings were “not a concern of ours at all.” And since markets see the Treasury as the administration’s voice on the currency, this change in tone is important.

Now, the dollar has already been weakening on its own – down 11% over the past year – but Mnuchin’s comments likely seal its fate. Where could it go? The DXY hovered around 80 for years (2009 to 2014), and that is still 10% lower than today’s levels. And with economic activity and interest rates slowly rising in Europe and Japan, the fundamentals point to a weaker greenback as well.

How do we make money with this notable change in language, backstopped by actual capital flows? For equity investors, the logical choice is to look at companies that have a high percentage of offshore revenues and profits. These will benefit from the translation of pricier rest-of-world currencies to cheaper US dollars. And if dollar weakness is to be a persistent trend this year, earnings revisions to capture this effect should cascade through 2018.

As a whole, the S&P 500 companies generate 30% of their sales from non-US sources. By sector, however, the story varies widely:

  • Technology: 60% non-US revenues
  • Materials: 47%
  • Energy: 42%
  • Industrials: 38%
  • Consumer Staples: 27%
  • Consumer Discretionary: 25%
  • Financials: 24%
  • Health Care: 18%
  • Real Estate: 17%
  • Utilities: 5%
  • Telecomm: 3%

We would split this list into three buckets in terms of investability in a weak dollar world:

#1. Bad. Real estate, Utilities and Telecomm are already under pressure because they are bond substitutes in equity portfolios. As rates rise, they have struggled. A lack of exposure to a lower dollar is just one reason to avoid them.

#2. Good. Financials, Health Care and Consumer Staples/Discretionary all run close enough to the S&P average for non-US revenues that the effects of a declining dollar are similar to the index as whole. Of the four, we like Financials the most for its exposure to faster global growth in combination with higher interest rates.

#3. Best. At the top of the heap, we believe Tech and Energy have the most going for them. The former is still an important leadership group, and the latter enjoys leverage to global oil prices. These are, of course, priced in dollars so a weaker USD should keep crude prices on an upward trend. Industrials and Materials should also do well in 2018, with catalysts ranging from global growth to a weaker dollar and even (hopefully) an infrastructure investment plan from the White House.

We’ll close on a cautionary note to balance the bullishness: a weaker dollar is not a free lunch. It will, at the margin, push long term Treasury yields higher as foreign investors require a higher coupon to offset a devaluing currency. Imported goods will cost more, spurring inflation. And, as with all things, the speed of the move matters to overall market stability.

On balance, we think a modestly weaker dollar will help US equity asset prices. Yes, we’re concerned that domestic stock prices have rallied too far, too fast (something we outlined yesterday in our note). That means Mnuchin’s comments aren’t a “Buy it all” signal. But a weaker dollar does provide one more fundamental tailwind, and at current valuations US stocks will welcome the shove.

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