Strong US dollar prompts equities sell-off

While selling United States equities has been a money-losing decision for six years, investors are doing it again amid concern wage growth will force the Fed’s hand on rates.

They have pulled US$7.1 billion from mutual and exchange-traded funds tracking American shares and sent $35bn to other markets this quarter, data compiled by Bloomberg and Investment Company Institute show.

The dollar’s ascent to highs not reached since the invasion of Iraq sent a shock wave through US stocks on Tuesday, erasing gains for the year over concerns earnings are in worse shape than investors recognised.

Dragged down by technology companies and banks, the Standard & Poor’s 500 Index slid 1.7 per cent to 2,044.16 on Tuesday, extending the loss from last week’s record to 3.5 per cent. Shares slid as the dollar posted its ninth gain in 10 days against the euro, a climb that threatens US profits and dramatises a bigger anxiety for traders, the Federal Reserve.

“It’s hard to stop the trend,” said Bill Schultz, who oversees $1.2bn as chief investment officer at McQueen, Ball & Associates in Bethlehem, Pennsylvania. “We’re stuck with a stronger dollar until we hear something more out of the Fed about modifying the trend toward higher rates, which isn’t likely.”

The upside in US equities will most likely be limited as the year progresses.

However, there will be periods where stocks will be prone to volatility, and this is when investors have the opportunity to make gains. And the start of the European Central bank’s quantitative easing programme this week is likely to result in more people borrowing money cheaply and increase “buying dip” activity.

The S&P500 is down 0.7 per cent in 2015, trailing all other 23 developed markets except for Greece. Tuesday’s drop was mirrored in Europe, where the Stoxx 600 Index lost 0.9 per cent. US 10-year Treasury yields fell to 2.13 per cent while German bund yields sank to 0.23 per cent, as European Central Bank bond-buying extended the yield premium. The MSCI Emerging Markets Index, denominated in dollars, fell for an eighth straight day.

In Europe investors buying on the dips led the Dax30 to another all-time high above 11,600 this week.

There are enough drivers for further volatility, according to analysts, notably that a rising dollar could affect corporate earnings in the US.

Currency markets created the pressure on Tuesday, with the dollar surging to an almost 12-year high versus the euro and the highest in seven-and-a-half years against the yen. The euro has fallen versus the greenback for eight straight months as the Fed wound down its quantitative easing programme and signalled a rate increase just as the ECB prepared to start stimulus.

“The overall worry in the market has to do with whether we’re going to see earnings growth,” said John Carey, a Boston-based fund manager at Pioneer Investment Management, which oversees about $230bn. “As long as earnings growth is thought to be stagnating this year, people may be thinking it’s time to pull in their horns.”

A 10 per cent strengthening in the trade-weighted dollar lowers the estimated 2015 profit for the S&P500 by about $3 a share, according to an earnings model created by Goldman Sachs Group.

After expanding at an annualised rate of 15 per cent since 2009, corporate profits are forecast to decline in the first and second quarters of this year, analyst estimates compiled by Bloomberg show. At the end of last year, analysts projected growth of at least 3.3 per cent for each of the two quarters.

Should S&P500 earnings fall for the first three months of 2015, it would mark the first period of negative earnings since 2009. The closest profits have come to contracting since then was the second quarter of 2012, according to Bloomberg data. That period also featured a strong dollar, with the currency climbing in May 2012 to its strongest level in two years versus its European peer.

“Stock investors are concerned that the best of earnings are behind us,” said Jeff Sica, the president and chief executive of the advisory firm Circle Squared, an alternative investments firm which oversees $1.5bn. “Growth has been relatively slow and in those conditions you can’t expect much.”

However, while a rising dollar might squeeze earnings in isolation, such moves don’t happen in a vacuum and a currency usually strengthens at the same time as an economy, according to Jonathan Golub of RBC Capital Markets.

GDP in the US will grow 3.1 per cent this year, according to economist estimates compiled by Bloomberg. That would be the biggest increase of the bull market. The economic measure has experienced growth of 2.5 per cent or below since the start of 2010.

“There’s no question that a stronger dollar is bad for earnings but it’s not bad for multiples,” Mr Golub said. “The biggest reason for the move in the dollar right now is changes in interest rates, and rates are going up because we are stronger and healthier. A lot of it does tie back to economic success.”

After last week’s US employment report showed the labour market is sustaining progress after the best annual performance in five years, investors are increasingly convinced the Fed will raise interest rates by the middle of the year, according to the Deutsche Bank chief US equity strategist David Bianco.

That could result in a decline of up to 9 per cent in the benchmark gauge, said Mr Bianco. On the way down, there will be plenty more opportunities for those looking to buy on the dips.

* with Bloomberg News

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