Credit Suisse Global Equity Strategy team believes that the dollar is likely entering a long-term bear market.
Dollar bull markets have typically lasted 6-7 years, and bear markets 9-10 years. We agree with our FX strategists' view of EURUSD at 1.22 in 12 months' time. Among the factors supporting the euro are valuation (12% cheap on PPP), the current account surplus of 3.4% of GDP, and PMI differentials. The euro is currently being driven by the long end of the curve, and in our opinion the 10y Bund yield has much more upside than the 10y UST yield. However, in the near term, we think some euro consolidation should be expected as it looks overbought, speculators are long and US rate expectations appear too cautious.
Other currencies: GEM currencies (ex the RMB) look nearly 30% cheap, with the ringgit and ruble looking particularly attractive. We have less directional conviction on sterling and the yen.
We stopped being GBPUSD bears last October but continue to see sterling depreciating against the euro (given our economists' modeled probability of a UK recession over the next six months is at 38%, a current account deficit of 4% of GDP, FDI inflows likely to revert lower and a dovish MPC). The main support is the rising probability of a softer Brexit, but the visibility on this will likely remain poor. Despite Japan clearly undershooting its inflation target, it is hard to be bearish on the yen (given the current account surplus, positioning and a declining pace of QE).
Implications: A weak dollar is good for global equities until the point at which the Fed is compelled to react to its inflationary impact; this would, we believe, require a further 10% depreciation. Each 10% off the dollar TWI adds c.5% to US EPS, on our estimates. We particularly like US-listed euro earners (Activision Blizzard, Priceline, McDonald's) and US tech.
In local currency terms, GEM is the only region that tends to outperform when its currencies strengthen (especially Indonesia, Turkey and Brazil). We find each 10% on the euro takes 6% off EPS. Peripheral Europe outperforms the core, with Germany and France the most negatively correlated to the euro.
On a euro area sector basis, banks, real estate and transport are the relative 'winners', while healthcare and consumer staples are least attractive. This highlights our overweight of banks, German real estate, and telecoms (the most domestic-oriented non-financial sector) and our recent downgrade of luxury. European stocks with more USD costs than revenues, which should benefit from a weaker dollar and have underperformed since 26 June include: Elementis, Ryanair and Solvay (all OP rated). The opposite is found for Vestas, Saipem, Wacker Chemie and Inditex.
We continue to favour UK euro earners (Vodafone, Bodycote, SThree). We think the Swiss franc will continue to weaken against the euro (our FX team forecasts EURCHF 1.18 in 12 months). The transactional mismatch helps Straumann, Geberit and private banks.