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Don’t cry too much about U.S. dollar weakness, especially if you’re a stock investor.
That’s the latest advice from Morgan Stanley strategists, who say a more than 8% drop for the U.S. currency this year so far will provide a nice tailwind for Wall Street earnings in the second half of 2017.
In addition to looser financial conditions provided by a weaker currency, a lower dollar has the potential to boost earnings and sales growth, said the team of equity strategists led by Michael J. Wilson. “Given the very strong U.S. dollar in the 2H16, this tailwind will only get stronger in 2H17, even if the dollar remains flat from here until the end of the year,” said Wilson, in a note to clients on Monday.
Given the dollar was so strong last year—the ICE Dollar Index finished up 3.5% in 2016 at 102.29, taking it to levels not seen since 2002—it will still finish 8% lower on an annual basis by December if it goes nowhere for the next few months, he said:
The ICE Dollar Index DXY, +0.11% which measures the greenback against a basket of currencies, has lost around 8% so far this year, with the bulk of those losses coming in the last three months. The dollar was inching up on Monday.
Wilson and the team expect the dollar index to range between flat and another 5% drop between now and the end of the year. That outlook is driven largely in part by their forecast that the euro EURUSD, -0.2486% will soar to $1.18 against the dollar this year.
The euro has been one of the biggest gainers against the U.S. currency, up around 8% so far in 2017 amid a more perceived hawkish tone by the European Central Bank, while soft U.S. data has led some to think that the Federal Reserve may have trouble increasing interest rates further.
The dollar has also had to contend with political uncertainty, as well central-bank uncertainty with the possibility of a new head of the Fed next year.
As for stocks that can benefit from all this dollar sagging, Wilson pointed to the usual suspects—multinationals with bigger international sales exposure.
“From our standpoint, this tailwind for 4Q sales and earnings could not come at a better time. Current 4Q bottoms-up S&P 500 EPS estimates forecast 13% y/y growth and quite frankly pose a risk to our positive outlook,” said Wilson, adding that a weaker dollar makes their forecast “much more achievable.”
So, how much benefit is there? The Morgan Stanley strategists estimate that every 1% fall in the dollar represents about 1/2 percentage point of extra forward earnings per share growth. So as the dollar has fallen this year, it should support forward EPS estimates, including the back half of 2017 and stretching into 2018.
“Therefore, an 8% fall in the DXY [year-over-year] by year-end should add roughly 4% to S&P 500 EPS in 2018 all else equal. Obviously in the further depreciation case in which the DXY ends the year -13% y/y, this would be an even greater and significant 6.5 percent boost to EPS,” said the strategists.
Nearly 200 S&P 500 companies SPX, -0.13% are due to report in the coming week, with earnings growth coming in around 7.2% so fare for the second quarter, and just 20% of companies have reported. Still, only tech and financials are expected to post year-over-year double-digit gains in profit, with seven out of eleven sectors due to turn in growth of low single digits or worse.