Credit Suisse says dollar bull market spells pain for airlines, UK retailers, telecoms

In a note on the "mighty dollar", Credit Suisse expects five more years to run on the current dollar bull market and predicts the euro will weaken much further, with tough times ahead for emerging markets, airlines, UK retailers, telecoms and utilities.

Noting that dollar cycles tend to last eight years, the Swiss bank believes we are three years into a "secular bull market" for the dollar.

The reasons for this are the sharp improvement in the US current account; encouraging private sector deleveraging that implies readiness withstand higher real rates; strong inflows of foreign direct investment; and the US being the only region where consensus GDP growth is still being revised upwards, with GDP 7% above the previous peak - much more than Europe & Japan.

While real rates and macro data point to the euro moving to $1.20, analyst Andrew Garthwaite and his strategy team foresee that, further out, "the euro might have to weaken another 10% to generate the inflation the ECB needs", while downside risk to sterling could see $1.44 and the yen could see ¥118 on a 12-month view.

"In local currency terms, we think Europe can outperform when the euro weakens (10% off the euro adds around 8% to EPS), as it did prior to 2005."

But the implications for companies are, of course, wide ranging, with analysts noting that equities do better in dollar bull markets, but that "potential losers" include several European sectors.

Stocks that are likely to lose from a weaker euro are those with significant costs in dollars.

"The clear example is the airlines, where nearly half of costs are dollar denominated, including fuel, aircraft and maintenance."

Euro weakness is also problematic for domestic non-cyclical sectors.

"The most obvious example of this is telecoms and, to lesser extent, regulated utilities. These two sectors also have abnormally high leverage and thus clearly suffer from the recent rise in spreads."

Significant UK-based dollar earners that have underperformed since the recent peak in cable are Ashtead, Senior, Shire, Smiths Group, Experian, UBM, Bodycote and Premier Farnell.

"On a sector basis in the UK, the clear loser historically from a weaker currency has been UK retailing."

In the US, defensives tend to perform best when the dollar is strong, with small and mid-caps having underperformed large caps historically.

"The US equity market is much more sensitive than the economy to a stronger dollar," the analysts note. "Imports account for only 14.2% of US GDP, and circa 80% of these are dollar denominated and thus compared to other regions, domestic inflation is relatively unaltered by currency strength."

From a sector positioning perspective, industrials and materials tend to underperform when the dollar rises, while
retailing has been among the domestic winners.

Global emerging markets (GEM) equities have outperformed only 33% of the time when the dollar is strong and the analysts point out that there are also plenty of other headwinds for GEM at present, inlcuding commodities, macro surprises, Chinese property.

"As a result, tactical GEM underperformance might continue a while longer."