Dollar’s Surprise Surge Challenges Stock Market Rally

Investors worried about the impact of the coronavirus on the world economy might soon have to confront another challenge to corporate profits: a strengthening dollar.

The U.S. currency has climbed steadily since the number of coronavirus cases began surging in China last month, pushing the WSJ Dollar Index to its highest level since early October. With many analysts concerned that disruptions to the Chinese economy will dent global growth, investors have been clinging to U.S. assets, helping the S&P 500 rebound from its late-January slide and rise last week to a fresh record.

Although major indexes and the dollar have climbed in tandem, U.S. companies including Johnson & Johnson, Coca-Cola KO 0.34% Co., Ford Motor Co. and 3M Co. have mentioned the negative effects of currency swings on earnings calls, highlighting a possible challenge to the longstanding bull market

A stronger dollar makes it more expensive for companies to bring home foreign sales and makes exporters’ products less competitive abroad.

Fourth-quarter profits for S&P 500 firms are on track to stay roughly flat compared with a year earlier, extending a trend from earlier in 2019. The combination of weak global growth and a strong dollar raises the possibility that earnings could disappoint again this year. Any negative impact from the dollar could amplify the fallout from the coronavirus, which has already forced chains from Starbucks Corp. to Nike Inc. to close stores in China temporarily.

Analysts expect S&P 500 profit growth to accelerate to 10% or higher in the last two quarters of 2020, according to FactSet, a projection that some investors fear will now be hard to hit. Investors will be monitoring results this week from a group highlighted by PepsiCo Inc., Cisco Systems Inc. and Nvidia Corp.

A rising dollar also affects emerging markets and commodities by making investments denominated in the U.S. currency more expensive for overseas buyers. Additionally, it becomes more costly for developing countries to service dollar-denominated debt when the currency climbs.

Multinational companies have already been under pressure, with earnings from S&P 500 firms that get more than half of their revenue outside the U.S. coming in worse than profits for more domestically oriented companies for much of last year. Many of those firms are now contending with the prospect of weaker Chinese demand and a stronger dollar.

The dollar and investments tied to U.S. growth also outpaced other assets for much of 2019, with analysts worried about trade tensions. As the new year started, many investors had expected the trend to reverse following an initial trade deal and clarity on the U.K.’s exit from the European Union.

“That story is now on hold,” said Emily Roland, co-chief investment strategist at John Hancock Investment Management. “We’re maintaining our preference for the U.S. because it’s the best from an economic growth standpoint.”

Still, some analysts don’t see the dollar climbing out of its recent trading range, particularly with the Fed indicating it plans to leave rates low for now. Many are skeptical that an unforeseen event such as the coronavirus that boosts the currency temporarily can provide longer-term support without also threatening economic growth in the U.S.

But for now, investors have kept buying U.S. assets. The yield on the benchmark 10-year U.S. Treasury note, which affects borrowing costs on everything from student debt to auto loans, fell last week to its lowest level since early October. Yields fall as bond prices rise.

Traders have also cited a reversal in investor positioning in explaining the market’s recent swings. Net investor bets on a stronger U.S. currency rose in three consecutive weeks through Feb. 4, after last month hitting their lowest level since 2018, according to the Commodity Futures Trading Commission and Scotiabank. The reversal is another example of many betting against the dollar, only for it to attract investors during turbulent times.

That bearish positioning “getting beaten out of the market has been a very consistent theme,” said Ed Al-Hussainy, senior interest-rate and currency analyst at Columbia Threadneedle Investments. “The safe-haven narrative is absolutely critical.”

Source: The Wall Street Journal
Graphics: The Wall Street Journal

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