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4 reasons why a strong dollar may sink the stock-market rally in 2017
By Jeff Reeves
Published: Nov 18, 2016 11:04 a.m. ET

The greenback has surged in recent days, with the benchmark U.S Dollar Index back above 100 to its highest levels since 2003.

It’s not secret as to why the dollar DXY, -0.40% is rallying. It’s nearly certain that the Federal Reserve will raise interest rates again at its December meeting while the rest of the world is still aggressively easing monetary policy, and President-elect Donald Trump has been very vocal about protectionist policies that include tariffs and other measures meant to rebalance U.S. trade relationships.

However, while it’s true that stock-market investors can’t fight the Fed and while the Trump trade has certainly been very profitable in the last week or so, there are serious challenges ahead if this dollar rally continues.

Admittedly, it’s hard to tell how much follow through we’ll see on Trump’s talk during the election. And in the age of Brexit and continued sluggishness out of China’s economy, it’s important to acknowledge that there are other big trends at play in the global economy right now.

But all things being equal, a dramatically stronger dollar is a huge wild card. And contrary to political talking points that play well with the unemployed workers of the Midwest, a significantly stronger dollar may not be the best thing for the stock market SPX, -0.24% or for U.S. businesses right now.

In fact, if the greenback keeps this up, it could put the brakes on the stock-market rally in 2017. And here’s why:

Another commodities collapse.

Unless you’ve been living under a rock, you should know that the current third-quarter earnings season will be the first period of year-over-year profit growth in the S&P 500 since the first quarter of 2015. And a big reason for that is because commodity companies have finally stopped the bleeding, thanks to a combination of deep cost-cutting and rising materials prices. After bottoming at under $27 a barrel, crude oil CLZ6, +1.71% traded over $50 as recently as October and gold GCZ6, +0.48% has rallied from a low around $1,050 to start the year to over $1,200.

However, we’ve already seen these commodity prices soften up as the dollar keeps pushing higher — and if that trend continues, we could see a lot of pain return to these sectors of the market.

Profit pain for multinationals

. While the Trump trade is theoretically good for American companies, investors haven’t acknowledged the reality that many U.S.-domiciled blue chips do the majority of their sales overseas. Consider that for all the talk about automakers moving jobs to China or Mexico, General Motors GM, -1.26% in 2015 sold 3.08 million vehicles to consumers in the U.S. — and 3.73 million in China and a total of 9.96 million vehicles worldwide. Or take MCD, +0.46% which did roughly a third of total revenue in the U.S. in 2015 —- just $8.6 billion of $25.4 billion in total sales. When you have to book the bulk of your sales in weaker foreign currencies, it weighs on the bottom line.

Emerging-market headwinds.

While the dollar index weighs the greenback against a basket of currencies, it’s worth noting that individual currencies have moved in much more dramatic way — particularly, emerging market currencies like the Mexican peso USDMXN, -0.6565% and Brazilian real USDBRL, -0.0443% That’s a troubling sign because a big differential in exchange rates will make it harder for American companies to compete against peers in Europe and Asia in these markets as U.S. goods become more expensive. Particularly in troubled emerging markets like Brazil, where economic growth has slowed in the last year or so, a big price differential for American goods will matter materially in how businesses and consumers spend their money.

Less corporate lending and spending.

There’s a reason we use the word “tightening” to describe monetary policies that result in rising interest rates and stronger dollar. A rising greenback limits lending by making it more costly to borrow in U.S. dollars — and that’s even more pronounced for those outside the U.S. In 2017, when corporations have less profits thanks to the aforementioned currency exchange rates and headwinds abroad, tighter credit could be a big factor. Less spending on capital improvements, acquisitions or other corporate efforts could weigh on future growth outlooks as well as year-over-year comps.

Finally, we’ve seen this movie before. It’s worth noting that the last time we were talking about a skyrocketing dollar, it was two years ago, at the end of 2014 and the dawn of 2015. The result was not pleasant for investors, as U.S. stocks basically finished 2015 right where they started, and the U.K.’s FTSE UKX, +0.43% and Germany’s DAX DAX, +0.31% both finished in the red. At the same time, both India’s Sensex 1, -1.47% and Hong Kong’s Hang Seng HSI, +0.06% finished down by double digits as the strong dollar destabilized emerging markets and made dollar-denominated debt much harder to pay back. The global economy hasn’t exactly gone like gangbusters in the last 24 months, so it may not be realistic to think that anything different will happen this time for global equities.