The dollar has strengthened, and the stock market is starting to notice.
The U.S. Dollar Index, which measures the greenback against a basket of currencies in Europe and Asia, is up almost 7% to about 107 from a major low point at the end of September.
The strength has been driven by rising U.S. government bond yields, making U.S. bonds more attractive to global fixed-income investors who have to buy more dollars to buy the country's bonds. The Federal Reserve might not be able to cut interest rates as many times as markets had previously anticipated. That's because inflation has remained stubbornly above the Fed's 2% goal, the U.S. continues to add jobs, and President-elect Donald Trump's planned tax cuts could increase the already-high budget deficit.
A higher dollar is problematic for stocks. Most companies in the S&P 500 index generate some of their sales from overseas. Those are lower when translated into a stronger dollar. It could also hurt global economic demand, since the dollar is the world's reserve currency.
A rising greenback doesn't always put an immediate dent in the stock market. Other forces keep the economy and companies' earnings growing, and analysts expect earnings for S&P 500 companies to continue to grow over the next couple of years. But when the buck goes up enough, investors realize that it will have a noticeable impact on earnings.
The market seems as if it's beginning to take note. The S&P 500 has essentially flatlined in December, after hitting multiple records this year. With bond yields and the dollar both up this month, the stock market cooled off from its recent run.
"The surge in the dollar has been an underappreciated headwind on risk assets in the second half of 2024, one that will continue to weigh on earnings," writes Sevens Report's Tom Essaye.
Companies that are vulnerable to a higher dollar are seeing their stocks get hit.
Philip Morris International, with almost all of its sales outside the U.S., has seen its stock fall almost 5% this month, while S&P 500 consumer staples stocks overall have barely moved. Coca-Cola, with about two thirds of its revenue in the past 12 months coming from overseas according to FactSet, has seen its stock drop 1.5% this month.
Mondelez International, with about three quarters of its revenue from overseas, has seen its stock drop almost 5% this month. Deutsche Bank analyst Steve Powers downgraded the snacks company to Hold, partly because of the dollar, Powers wrote in a Wednesday note.
Oracle stock is down just over 7% in December. The software company gets about 45% of its revenue from overseas. Its fiscal second quarter earnings out this week, while beating estimates, included current quarter guidance for sales to increase 8% year over year to $14.38 billion. That's a few hundred million dollars short of analysts' previous forecasts of 10% growth. The company cited the stronger dollar.
The good news for U.S. investors is that the dollar has already made a move higher, and its strength is already becoming reflected in stock prices. If the dollar weakens next year, it will become a "tailwind," or a positive factor, for earnings. If the dollar index is down from 107 for the final quarter of next year, it would act as a factor supporting earnings growth.
But a break above 107 would indicate that currency traders have shifted their tone, more positively, on the dollar. If it breaks above 107 or 108 for an extended period, it could then race to new highs -- its record high is about 118 -- writes John Kolovos, chief technical strategists at Macro Risk Advisors. That could spell trouble for the stock market.
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