With the Federal Reserve nearing the end of its most disruptive monetary-tightening campaign in a generation, a softening US dollar is poised to boost profit growth for nearly half of the companies in the S&P 500 Index over the next year.

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(Bloomberg) — With the Federal Reserve nearing the end of its most disruptive monetary-tightening campaign in a generation, a softening US dollar is poised to boost profit growth for nearly half of the companies in the S&P 500 Index over the next year. 

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As speculation grows that the US central bank plans to halt interest-rate hikes soon, traders are wagering that the dollar, which has declined over 10% from a peak in September, could lose more steam. A pullback in the greenback should, in turn, help companies that sell goods overseas and have been vulnerable to rate hikes and the ramifications of a strong greenback. 

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“The perception that the Fed is near the end of its rate cycle has weakened sentiment toward the dollar — a key risk-on signal for the stock market this year and a boon for Corporate America,” said Michael Sheldon, the chief investment officer at RDM Financial Group. “While corporate profits still need to improve, a weaker dollar is a bullish tailwind for multinational firms that obtain a significant portion of their revenues from overseas.” 

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What’s more, dollar weakness has room to run after the Fed said this week that further rate increases would be data dependent, bolstering traders’ hopes that the hikes are near an end.

That sets the stage to support corporate profits in the quarters ahead since roughly 44% of the companies in the S&P 500 have earnings per share that is negatively correlated with the US currency, according to data compiled by Bloomberg Intelligence. That encompasses nine of 11 industry groups in the index, led by sectors including tech, communications, consumer staples and materials, the data show.

RBC Capital Markets also notes that more than a third of companies in the S&P 500 derive a portion of their revenue from outside the US, led by technology firms that generate more than 50% of their sales overseas.

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Historically, rolling annual drops in the dollar between 6% and 8% have resulted in trailing 12-month earnings-per-share growth of nearly 19% the following year, according to data compiled by Bloomberg Intelligence. That’s more than double the S&P 500’s long-term rolling average earnings growth of 8.3%. 

In fact, the most negatively correlated stocks in the index comprise just 22% of its market value, which is heavily weighted toward tech and communication services bellwethers like Microsoft Corp. and Meta Platforms Inc. — Big Tech stocks that have helped power the S&P 500 to a 19% rally in 2023.

Of course, the real estate and health care sectors — two groups in the S&P 500 that obtain just 20% of their revenues from abroad  — likely won’t benefit as much from an easing dollar, along with financials.

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Still, a declining US currency makes import costs more expensive, which could offset some of the benefit of a softer greenback. Another near-term challenger is that the currency may hold around current levels until the Fed signals that it’s officially shifting from raising rates. 

Part of the reason is because the US Dollar Index broke below major support levels in June to trade near its lowest level in over a year. Its 14-day relative strength index is back to a level near 50 after reaching 70 in mid-June, which some market technicians view as a sign of oversold conditions. That may limit its drop in the coming weeks. 

“The dollar is oversold in the near term, but it has more room to fall over the next year,” said Adam Phillips, director of portfolio strategy at EP Wealth Advisors. “That’s a tailwind for corporate profits.”

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Wall Street analysts project that S&P 500 companies will see the biggest contraction in earnings growth during the second quarter, where profits are expected to fall by 9% year-over-year. With about 57% of companies in the index having reported, profit growth for the period is on track to have contracted by 9.2% thus far. But earnings growth is actually improving when the energy sector is excluded.

“Slowing global growth offset by easing inflation prospects and AI optimism are the big themes likely to dominate S&P 500 earnings seasons in the second half of 2023,” according to Gina Martin Adams, chief equity strategist at Bloomberg Intelligence. “But the US dollar’s recent decline could add a leg of support for nearly half of the index as well.”

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