Morgan Stanley: Strong dollar puts pressure on US stock earnings season, significant differentiation will occur

Zhitong Finance has learned that Morgan Stanley strategists have stated that a strong dollar may lead to significant discrepancies in U.S. corporate earnings reports this season, with industries oriented towards the domestic market outperforming those with substantial international revenues. Since Trump won the presidential election last November, the dollar has appreciated significantly due to market expectations that his tax and tariff policies may trigger inflation. The resilience of the U.S. economy has also led to bets that the Federal Reserve may maintain higher interest rates for a longer period, further boosting the dollar.

The Morgan Stanley team led by Michael Wilson stated that a strong dollar typically results in greater performance discrepancies among S&P 500 constituents, as the international sales of these constituents account for less than 30%. He believes that household products, technology hardware, and food and beverage stocks have the largest overseas exposure, while telecom services and utility stocks have the least risk.

Wilson wrote in the report: “We believe that a strong dollar may be a key factor in the widening performance discrepancies this season.” The strategist said he expects the recent poor performance of industries more closely tied to the dollar to continue.

Strong Dollar Momentum Hard to Stop

Meanwhile, Goldman Sachs has raised its forecast for the dollar, citing the strength of the U.S. economy and the tariff policies proposed by the Trump administration that may slow the Fed's easing of monetary policy. Goldman Sachs strategists, including Kamakshya Trivedi, stated in a report: “We expect the dollar to rise by about 5% over the next year as new tariffs are implemented and the U.S. economy continues to perform strongly.”

Moreover, Goldman Sachs added that even after raising its forecast for the dollar, it still sees risks of further strengthening. The bank stated that this may be partly because, despite the increase in tariffs, the U.S. economy may still remain resilient. The bank said: “While we acknowledge that forex market participants clearly expect some degree of change in tariff policies and it is difficult to ascertain the drivers of recent trends, we believe the dollar will strengthen further in the future.”

It is reported that this is the second time Goldman Sachs has raised its forecast for the dollar in about two months, citing the continued strong growth of the U.S. economy and the tariffs proposed by Trump that may exacerbate inflation and lead to a derailment of the Fed's easing policies. The U.S. non-farm payroll report for December released last Friday reinforced views on the resilience of the job market, further enhancing market expectations for a stronger dollar.

Strong Dollar Combined with Rising US Treasury Yields May Pressure US Stock Market

Wilson stated, "As long as robust US economic growth is the main driver for the dollar's rise," the overall performance of the S&P 500 index may remain resilient. In mid-2024, this strategist abandoned his long-standing pessimistic view on the US stock market.

However, the technology sector, being a major component of the S&P 500 index, has a high proportion of business and revenue coming from overseas, and a strong dollar may have negative financial impacts on these companies. According to FactSet, the US information technology, materials, and communication services sectors have the highest international revenue exposure, with overseas revenue accounting for 57%, 52%, and 48% of total revenue, respectively. Moreover, the seven major tech giants driving the S&P 500 index upward also have a high proportion of overseas business.

According to estimates from Bank of America Global Research, for every 10% year-over-year increase in the dollar, the earnings of S&P 500 constituent companies would decrease by about 3%. Additionally, companies that are vulnerable to a strong dollar must also invest resources to implement hedging strategies to offset the impact of dollar appreciation on their profits.

Furthermore, although analysts have lowered earnings expectations ahead of the fourth-quarter earnings season, Wilson noted that expectations remain relatively high compared to recent quarters, raising the bar for companies to exceed expectations. Goldman Sachs CEO David Kostin also stated that he expects earnings growth this quarter to be "moderate."

The upward momentum of the US stock market has weakened in the new year due to a more hawkish outlook from the Federal Reserve, leading to soaring bond yields. As the yield on the 10-year US Treasury approaches the critical 5% threshold, investors and strategists warn that the US stock market may face further pain.

Traders are also closely monitoring the policy-sensitive 10-year US Treasury yield, which briefly surpassed 4.8%, the highest level since October 2023, and is rapidly approaching 5%. They are concerned that this level may trigger a market correction. The last brief breach of this threshold occurred in October 2023.

Matt Peron, head of global solutions at Janus Henderson, said, "If the 10-year US Treasury yield hits 5%, investors will instinctively sell stocks. Events like this can take weeks or even months to resolve, during which the S&P 500 index could drop by 10%."

The reason is simple: rising bond yields make US Treasuries more attractive while also increasing corporate financing costs. The yield on the S&P 500 index is 1 percentage point lower than the yield on the 10-year US Treasury, a situation not seen since 2002. In other words, the returns on assets with far lower risk than US benchmark stocks have not been this good for a long time Wall Street strategists and portfolio managers predict that the road ahead for the stock market will be bumpy. Wilson expects that the U.S. stock market will face a tough six months, while Citigroup's wealth management division is telling clients that there are buying opportunities in the bond market