The DXY Dollar Index had a bit of a rally today, up 0.5 percent, and is 1.1 percent higher than the middle of last week; these moves are getting some attention in the financial press so let’s talk about the direction of the dollar and what it means for stocks.
First, not to be that guy who always says, “actually…”, but actually the DXY Index isn’t a great way to measure the dollar’s strength if you want to understand the impact of the greenback on either corporate earnings or macroeconomics:
- The DXY is 58 pct weighted to the euro, 14 pct to the yen, 12 pct to the pound, and 16 pct a combination of Canadian dollar, krona and Swiss franc.
It does not include the Chinese yuan, for example, or the Mexican peso. Or the South Korean won, or anything else.
- The Federal Reserve’s trade weighted dollar is a more representative measure of the dollar’s relative value. It includes the yuan (16 percent), peso (13 percent) and other major US trading partners like Brazil (2 percent) and South Korea (3 percent) as well as everything in the DXY Index.
Here is the annual percentage change in the Fed trade weighted dollar index back to 2007, with a highlight box showing its worst year-on-year decline (March 2010, one year after its Financial Crisis highs):
Focus on the ebb and flow of the dollar around the 2 shaded periods (grey, Great Recession and yellow, Pandemic Recession), and you can see we are basically replaying the 2009 – 2010 experience in terms of the dollar weakening during the early stages of a global cyclical recovery. In fact, if the trade weighted dollar just holds right here (111.6 is the actual level as of last Friday) through March 23rd, 2021 we’ll see the same 11.7 percent decline as we did in 2010 (highlighted in the boxed data item above).
To get the whole picture of where the dollar can go in 2021, however, we need to look at the index data back to 2006 to see that the March 2009 high for the greenback (106, highlighted in the graph below) was actually 16 percent lower than the 126 level we saw in March 2020:
The upshot here is that if one believes the global economy will track towards a more normal macro environment in 2021/2022, then the dollar potentially has further to fall than even during the post-Great Recession recovery.
From a stock market perspective, that’s pretty good news because as we noted in our Markets section the big question just now is “how robustly can corporate earnings recover this year and next?” A weaker dollar means offshore profits translate back at more favorable rates and boost reported profitability. Not all sectors have the same international exposure, however. Here is the FactSet data for each S&P 500 industry group’s current non-US revenue exposure (link in sources below):
- Technology: 58 percent
- Materials: 55 pct
- Consumer Staples: 44 pct
- Energy: 41 pct
- S&P 500 in total: 40 pct
- Communication Services: 40 pct
- Health Care: 38 pct
- Industrials: 35 pct
- Consumer Discretionary: 33 pct
- Financials: 22 pct
- Real Estate: 17 pct
- Utilities: 3 pct
Summing up: it may sound counterintuitive to think a less-valuable dollar is a positive macro signal, but history shows that global recoveries come with a weaker greenback. Moreover, from a stock market perspective a weakening dollar is a tailwind to profitability. Lastly, it’s hard to miss that the largest sector in the S&P 500 (Tech is 27 pct of the index) is also the most exposed to a weaker dollar.
Non-US Revenue Percentages (p. 22): https://www.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_010821.pdf