Don’t Fear King Dollar

This bear market has been relentless! Between sticky inflation, a hawkish Fed, and a looming global recession, bulls can’t seem to catch a break. As if that weren’t enough, the surging US dollar is quickly moving up investors’ worry list.

But don’t fear king dollar. Rather, understand how a strong dollar impacts stocks. Then you’ll be positioned to profit.

The greenback hasn’t been this strong in 20 years. The US Dollar Index is up an epic 28% since May 2021. That’s a big burst. The average historical gain during much longer, strong dollar regimes has been 24%.

Today, I’ll show you what’s driving the greenback’s extraordinary rally and whether it can last. Then, I’ll lay out what that means for stocks and which sectors look best positioned.

The Best Benchmark: The US Dollar Index measures the greenback’s performance vs. major currencies. Each foreign currency is weighted according to how much that country trades with the US. Note the euro represents a whopping 56% of the index. $/€ is the key FX cross rate the pros watch.

Don’t Fear King Dollar – Why the Dollar is Rising

Fed Rate Hikes: Rising US bond yields make dollars more attractive than lower-yielding foreign currencies. That’s why the dollar has been tracking 2-yr. Treasury yields higher.
Stronger US Growth: COVID shutdowns in China, and the war in Ukraine, have prompted investors to bet the US economy will fare better than rivals in Europe and Asia.
Flight to quality: Fears about a global recession have driven investors to seek higher quality, “safe haven” assets like the US dollar.

How a Strong Dollar Impact Stocks

Revenue Risk: S&P 500 companies generate roughly 40% of their sales overseas. When the dollar strengthens, overseas sales are worth less when translated back into US dollars.
Earnings Risk: Historically, every 10% gain in the dollar shaves 1% from S&P 500 EPS growth. If the USD rally persists at this pace, it would cut 2023’s estimated 7% S&P EPS growth to 4.5%.
Performance Risk: Given the negative impact of dollar strength on equity fundamentals, it’s no surprise the S&P 500 has been falling as the greenback has rallied (chart).
Sector Risk: Tech has the most foreign exposure at 58% of sales. Staples is #2, energy #3.

Why the Dollar May Be Peaking?

We know a strong dollar is bad news for stocks. The good news is the greenback’s rally is finally easing.

Higher rates have really boosted the buck. As growth slows and inflation finally shows signs of easing, markets are beginning to position for slower Fed rate hikes.

The US Dollar Index and the 2-year Treasury yield – the market proxy for the Fed Funds rate – both peaked on September 30. It’s no surprise the S&P 500 & MAPSignals’ BMI both bottomed the same day! Let me say it again, don’t fear king dollar!

How to Play It?

The S&P 500 averages a 10.3% gain in years following major peaks in the US dollar. Better yet, discretionary, financials and health care are the 3 best performing sectors when the dollar falls, chalking up healthy 12-month gains of 22%, 21% and 17%, respectively (chart).

Check this out. MAPsignals’ Big Money Index (BMI) is sending the same bullish signal as the toppy US dollar and 2-year Treasury yield. The BMI’s been a really reliable contrarian buy signal for stocks when it reaches oversold.

Take a look at the 3-year chart below. The BMI just went oversold. The last 3 times the BMI went oversold were in March 2020 and then again in June and early July of this year. All of these oversold BMI signals preceded huge equity rallies:

Let’s dig deeper into the 3 sectors that do best when the dollar weakens. Health care sports the 2^nd highest sector MAP Score of 54.5 with financials close behind at 52.5. Discretionary’s score is only 47.3 overall, but its 60 fundamental score is second only to the tech sector (table). All 3 sectors have recently seen big selling dry up as big money buying builds.

The Top Ranked Stocks by sector can be found in our portal for subscribers. It updates daily.

Bringing It All Together

The dollar rally is looking very long in the tooth. Fed tightening and soaring 2-Yr. Treasury yields are still propping up the greenback, but its ascent is clearly slowing. Sooner or later the Fed will be forced to acknowledge the toll its YTD tightening is having on economic growth and inflation. The dollar is ripe to fall at the first hint of a slowdown in Fed rate hikes. Once that happens stocks will rip higher.

The most profitable time to buy stocks is when it feels uncomfortable. If you wait until buying feels good, you’ll pay a big premium. Now is the time to position for a more favorable macro environment. And remember, don’t fear king dollar.

Invest well,

-Alec

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