On September 18, 2022, The Wall Street Journal ran an article titled “Dollar’s Rise Spells Trouble for Global Economies: The surge threatens to exacerbate a slowdown in global growth and amplify inflation headaches for global central banks.”
Sounds ominous, right? I’ll spare you all the textbook-like explanations on the whys and the hows of how a rapidly rising dollar could negatively affect economic growth. Just know for now that the headline is an accurate assessment. Around the time the WSJ article was published, large U.S. companies cited the strong dollar during their earnings reports as a culprit hindering revenue and profits. About 30 percent of the revenue from companies in the S&P 500 index comes from sales outside the U.S. As the dollar strengthened, their products became more expensive for global customers, and they sought non-U.S. alternatives. According to research by Evercore ISI, for every one percent move in the dollar, S&P 500 earnings get hit by 20 to 30 basis points (i.e., 0.2 to 0.3 percentage points). Others estimate more. But there is agreement that the dollar’s strength was a headwind for stock investors in 2022.
When the WSJ wrote that column, the ICE U.S. Dollar Index, which measures the currency against a basket of other currencies, was trading at a 20-year high. It peaked around then; it was up more than 14 percent year-to-date, on its way to a 16 percent increase. Since then, the Dollar Index has dropped more than 10 percent. According to Bespoke, that is the sixth time since 1980 that the Dollar Index dropped that much from a high. Of those occurrences, four of those declines began at levels near the September 2021 high (only the 1985 high was significantly higher).
Since the higher dollar was a headwind for stock prices, you’d be correct to assume that a lower dollar becomes a tailwind. The S&P 500 rose an average of 19.09 percent in the year after the five previous dollar peaks, according to Bespoke.
That one-year return would bring the S&P 500 close to its previous high. After a brutal 2022, it sounds too good to be true. And maybe it is. But it suggests that risk to stock investors is dissipating.
The Risk of Global Economic Strength
One of the most significant risks to the U.S. stock market is that the Chinese economy could boom in 2023. Chinese consumers had been trapped in their homes for long parts of the pandemic as the country adopted a zero-COVID-19 strategy. China is beginning to reopen its economy, allowing households to act on their pent-up demand for goods and services. Chinese consumers have accumulated more than $2.2 trillion in bank deposits.
The good news is that the reopening of China will help improve the remaining supply chain issues. Eventually. However, first Chinese consumers will likely do what Americans did: Try to buy more of everything before it is available. The shopping list for Chinese consumers should include U.S. goods, which are now cheaper to them because of the weaker dollar. Normally, that would be clear-cut good news for American companies and their employees. But inflation has been and continues to be the number one economic story. (Even if the path of interest rates is the number two story, it’s only because of high inflation.) More demand will push prices up and make the Federal Reserve’s job of taming inflation more difficult. The consequence may be that the Fed would have to keep interest rates higher for longer. That is not good news for corporate earnings growth and the stock market.
Besides supply chain issue, oil prices are top of mind for consumers worried about inflation. China’s reopening would push global oil demand to a record 101.7 million barrels per day, according to the International Energy Agency.
In December, U.S. inflation growth fell for the sixth consecutive month. Gasoline prices have dropped considerably from their peak and have been trending toward flat year-over-year. Inflation was on a mathematical path to be cut in half from its peak by the second half of 2023, which would make achieving the historical-average 12-month gain of 19.09 percent following a peak of the Dollar Index more possible. Now, in what feels like a darkly ironic twist, something that should be a big positive for the global economy could become an obstacle for the U.S. stock market.
