The US dollar is currently down by nearly 10% on a nominal, trade-weighted basis since the end of 2016, which has contributed to rising US company earnings. Earnings-per-share (EPS) estimates have also been boosted more recently by the anticipated benefits of US tax cuts (see exhibit 1).
The weakness can be attributed to a number of factors including high US asset valuations, widening US trade and budget deficits and official comments pointing to a weak dollar policy.Exhibit 1: S&P 500 next-twelve-month (NTM) EPS estimate and US dollar index Note: 100 = 31/12/2016. Source : FactSet, Bloomberg, BNP Paribas Asset Management, as of 22/02/2018.
Weaker US dollar has helped index returns...
S&P 500 listed companies earning a higher share of revenues from outside the US have generally outperformed more domestic-oriented sectors over the last year. The correlation between the share of international revenues and the industry index returns since 31 December 2016 is 33%.Exhibit 2: S&P 500 industry international revenue share and index returns since 31/12/2016 Source: FactSet, BNP Paribas Asset Management, as of 22/02/2018
For the 268 companies in the index that have reported foreign sales for 2017, foreign revenues grew by 12% from 2016 to 2017 compared to just 5.1% growth in domestic revenues (and total S&P 500 net income growth of 19%), so the weaker dollar has clearly helped. Net income growth, however, was not higher for international than for domestic-oriented industries, which is logical as domestic drivers are still more important for US corporations.
...and net income growth
Foreign sales represent just 29% of total S&P 500 sales, but relative to previous earnings expectations, stocks in more internationally oriented companies would have gained on the margin by the US dollar’s depreciation.Exhibit 3: Net income growth (2017/2016) and S&P 500 industry international revenue share Source: FactSet, BNP Paribas Asset Management, as of 22/02/2018
By comparison, foreign sales represent 65% of total sales for the MSCI Europe, though this includes intra-eurozone sales. As for the euro, it is worth noting that its appreciation occurred primarily in the first half of 2017. On a trade-weighted basis, the single currency has been largely flat since August 2017, meaning any drag on earnings from that appreciation should have largely faded by now.
Is it US dollar weakness or the tax cuts?
US earnings estimates are still likely to be revised higher given consensus expectations that the US dollar will continue to depreciate, but it is difficult to separate the impact of the US dollar on earnings revisions from that of the tax cuts.
Since December 2017, analyst estimates of 2018 tax expense for S&P 500 companies have fallen by 20%, although those companies expected to get a bigger tax cut have seen commensurately higher EPS revisions (see exhibit 4).Exhibit 4: Change in NTM EPS and tax expense estimates since December 2016 Source: FactSet, BNP Paribas Asset Management, as of 22/02/2018
At this point, EPS estimates likely already reflect most of the expected tax cut benefits, whereas additional depreciation (or appreciation, if you’re contrarian) of the US dollar should continue to feed through. Here are the top (and bottom) industries by foreign revenue share. We believe the top industries should continue to outperform.Exhibit 5: top and bottom industries by non-US revenue share Source: FactSet, BNP Paribas Asset Management, as of 22/02/2018