US dollar strength, typically a bearish sign for investment markets, is returning with a vengeance taking the trade-weighted dollar index (DXY) to its highest level in four-and-a-half years. This could lead to earnings upgrades for companies which previously saw forecasts slashed this year thanks to sterling?s earlier strength against most other major currencies, including the US dollar. We highlight consumer staples business Unilever (ULVR) and rental specialist Ashtead (AHT) as particular beneficiaries.
The surge in the dollar index from around 80 at the start of July to 85.6 is attributed by analysts at investment bank Morgan Stanley to rising government bond yields in the US and uncertainty over the Chinese economy. Alongside the now familiar arguments over the uncomfortable portents this has for financial markets, dollar strength may also offer up some interesting opportunities among stocks.
Businesses exposed to the US economy have generally performed better than their benchmarks over the past six months. As we recently highlighted (see Shares, Opinion, 25 Sep), stocks including Ashtead, cruise operator Carnival (CCL) and publisher Pearson (PSON), each of which generate the bulk of the earnings in the US, have produced market-beating returns.
There are other ways of playing rising dollar strength. The first is to buy stocks in markets with weaker currencies, notably businesses which benefit from a weaker euro. UK-listed stocks that fit the bill include Unilever and gambling outfit Paddy Power (PAP). Operating profit and revenue at both are boosted by a weaker euro because they generate more than two thirds of their sales outside the EU. That may not help UK-based dividend investors as both pay dividends in euros.
The second, according to the Morgan Stanley team, led by analyst Graham Secker, is to look at investments in European companies which would benefit from increasing business confidence. Higher capital expenditure and general business-to-business spending would likely benefit building materials outfit CRH (CRH), advertising agency WPP (WPP) and gambling technology group Playtech (PTEC). All earn more than 98% of their sales from corporate customers.
Finally, while valuations of companies exposed to the US economy have risen significantly, those which sell internationally but earn in dollars have lagged. One such laggard is temporary power provider Aggreko (AGK), which has performed 3% worse than the MSCI UK benchmark over three months, even though Secker?s analysis indicates a ?very positive? impact on its operating profit from a stronger dollar.
