Mitch Zacks: What Investors Should Know About a Weakening U.S. Dollar

The assumption that a weak dollar means a strong market, or vice versa, does not hold up against history. Read Mitch's analysis here [Mitch on the Markets] What Investors Should Know About a Weakening U.S. Dollar From late 2021 through September 2022, the U.S. dollar strengthened in a historic rally as the Federal Reserve aggressively raised rates and tightened monetary policy. As seen in the chart below, the big move for the dollar also corresponded with a nearly year-long bear market in stocks.1 [MOTM_07292023_graph1] Source: Federal Reserve Bank of St. Louis 2 [How Are Your Investments Affected in Today’s Market?]( If you’re looking for current market forecasts to better guide your investing decisions, I recommend taking a look at our new August Stock Market Outlook Report. Today, this briefing is exclusively available to Mitch on the Market readers. Before you make short-term (or long-term) decisions for your investment portfolio, catch the latest consensus on: - Top-down S&P500 yearend 2023 and 2024 targets - Zack’s view on equity markets - Setting U.S. returns expectations for 2023 - Zacks Rank S&P500 sector picks - Zacks rank industry tables - And more… If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today! [Download Our Just-Released August 2023 Stock Market Outlook Report 3]( --------------------------------------------------------------- The dollar peaked late last year, however, as the market started to anticipate an end to rate increases sometime in 2023 – which happened to align with Europe and other major central banks turning up the heat on tightening. The dollar historically weakens on lower-than-expected inflation, which describes the outcome in the U.S. but certainly not in Europe, where inflation is proving stickier. Other events in 2023 also pressured the dollar lower. The regional bank stress spurred concern about a larger crisis in the banking system, months of debt ceiling drama led to fear of default, and for months there was broad consensus that the U.S. was charging towards a recession. As the dollar weakened, stocks rose. Some analysts are pointing to the dollar breaking through a key support level as the driver behind the “risk-on” rally. I’m not so sure. The assumption that a weak dollar means a strong market, or vice versa, does not hold up against history. If we take the same U.S. Dollar Index chart as you see above, and zoom out to look back over the last 15 years, you can see that the dollar is strengthening (2011 – 2020) throughout one of the strongest bull markets in history: [MOTM_07292023_graph2] Source: Federal Reserve Bank of St. Louis 4 For investors, I think the weak dollar story is about earnings. The biggest beneficiaries of a weakening U.S. dollar are U.S. large-cap companies, namely multinationals. In many cases, multinationals can generate more than half of their revenue abroad, which means they’re being paid in euros, yen, etc. When those foreign earnings are converted back to dollars, the company naturally earns more dollars as the currency weakens. In these cases, market forces help boost profits. To offer an example, back in 2022 when the dollar was strengthening, the surge ended up subtracting somewhere in the range of 5% to 7% from S&P 500 earnings per share (EPS) results. The biggest multinationals felt the biggest impact. In 2023, with the dollar weakening by approximately 13% from the September highs (as I write), we should see the opposite – a nice boost to earnings in upcoming quarters with weak year-over-year comparisons. The companies that benefit the least from a weakening dollar tend to be small-caps. These are companies that tend to source inputs from overseas. When the dollar weakens, the costs of overseas production and imports go up, which if not offset by higher prices can adversely impact profit margins. Small-caps also tend to sell their goods and services domestically, meaning they cannot take advantage of favorable conversion rates on foreign income. From the standpoint of the global economy, the weaker dollar tends to generate more good news than bad. Approximately 60% of global liabilities are denominated in dollars, with much of this being Emerging Markets sovereign debt. As the dollar weakens, the cost of servicing or repaying dollar debt goes down, which provides relief to foreign companies and governments and frees up spending. And, since many goods are priced in dollars from a global trade standpoint, a weaker dollar makes goods more affordable to international buyers. As total trade rises, the global economy grows. Bottom Line for Investors Whether the dollar will continue to weaken from here – which would arguably strengthen the positive earnings thesis for large-caps – the answer is unclear. From a monetary policy standpoint, the U.S. appears poised to diverge from other major central banks, and rate differentials are a key driver of currency markets. But on the other hand, history suggests that the end of the rate hike cycle could lead to a few-month period of further weakening, followed by stabilization and strengthening as capital flows back to the U.S. For investors, the earnings impact is what matters most, in my view. I’ve mentioned in previous columns that Zacks expects earnings rebound to take hold by Q4 of this year. With easier earnings comparisons in the fourth quarter (compared to Q4 2022), stable demand and spending data, and a weaker dollar, I expect large-cap multinationals could experience a nice bump in profits. If you’d like to get more insights on specific investment factors, such as data, to better maintain your portfolio, I’m offering our [Just-Released August 2023 Stock Market Outlook Report](. This report will give investors a deeper insight into: - Top-down S&P500 yearend 2023 and 2024 targets - Zack’s view on equity markets - Setting U.S. returns expectations for 2023 - Zacks Rank S&P500 sector picks - Zacks rank industry tables - And more… If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today! [Download our Just-Released August 2023 Stock Market Outlook 3]( About Zacks Investment Management Zacks Investment Management was born out of one of the country’s largest providers of independent research, Zacks Investment Research. 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