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The strong dollar has an unexpected victim

<i>Spencer Platt/Getty Images</i><br/>The strong dollar has been a headwind for blue chip US companies in the Dow and S&P 500 this year.
Getty Images
Spencer Platt/Getty Images
The strong dollar has been a headwind for blue chip US companies in the Dow and S&P 500 this year.

By Paul R. La Monica, CNN Business

The strong dollar has been a headwind for blue chip US companies in the Dow and S&P 500 this year.

That’s understandable since a surging greenback eats into the international profits of companies like Apple, Procter & Gamble, McDonald’s and Coca-Cola, which all have significant exposure overseas.

But it may come as a surprise that smaller US companies, which tend to have a more domestic focus, have not held up better during this time of dollar strength.

What’s happening: The S&P SmallCap 600 index has plunged 22% this year, only slightly less than the S&P 500′s 25% drop. And the Russell 2000, another index of mostly smaller companies, is down 25%, too.

That’s unexpected given the profile of small cap companies. “Small cap equities are…more US centric in their revenue exposure and less likely to be hurt by a stronger US dollar than large multinationals,” said Jim Besaw, chief investment officer of GenTrust.

Note that he said “less likely to be hurt.”

The problem is that investors are worried about a looming economic slowdown in the US, so any benefit from a stronger dollar — i.e. less exposure to the global economy — is being offset by recession worries domestically.

Also, the dollar is so strong — the US Dollar Index, which tracks the greenback against the euro, pound, yen and several other currencies has soared 18% this year — it’s making foreign imports cheaper. That is bad news for smaller US companies trying to compete with rivals from Europe and Asia.

However, the Federal Reserve won’t be aggressively hiking rates forever. The market is starting to price in the possibility of some small rate cuts at the end of 2023. That should, in theory, cause the dollar to start to lose some of its value.

Meanwhile, some experts think there are parts of the US market where investors can hide, even among larger companies.

“More domestic-focused sectors, such as real estate and utilities, are less exposed to these effects. The US dollar remains a headwind to international stocks and corporate revenues, but may not continue to rise indefinitely,” Glenmede investment strategists Jason Pride and Michael Reynolds said in a report.

Utility stocks have held up marginally better than the rest of the market. The S&P Utilities index is down “only” 11% this year. That’s partly due to the fact that utility stocks are considered more recession resistant. Consumers are still likely to pay electric and water bills even in a downturn.

Utilities also pay big dividends, which are even more attractive in a market this volatile.

But real estate stocks have been slammed by worries about a housing and office real estate slowdown. The S&P Real Estate index has plunged 33% this year.

The bottom line: Nothing is totally immune to the effects of a strong dollar. Sure, some sectors may not be hit as badly as others. And multinational companies and foreign stocks will fare more poorly than smaller companies with little to no international exposure.

But as long as the Fed continues to raise rates, the dollar is unlikely to weaken significantly. That will continue to be a problem for American consumers and investors.

“It’s a challenging environment for everybody,” said David Jilek, chief investment strategist at Gateway Investment Advisers, noting above average volatility for the markets is likely to persist until the first quarter of 2023 at a minimum.

So much for those big UK tax cuts

The new finance minister in the United Kingdom is already reversing what was meant to be a signature economic plan of British prime minister Liz Truss. Jeremy Hunt said he is undoing “almost all” of the major tax cuts that Truss’s previous financial chief, Kwasi Kwarteng, had put into place. Kwarteng was fired on Friday.

As my colleague Julia Horowitz reports, this is a stunning reversal. It amounts to “a gutting” of Truss’s growth plan. But the backtracking appeared to be necessary in order to assure nervous investors, who sent the value of the pound plummeting in the past few weeks due to worries about the government’s spending plans.

Even US President Joe Biden was skeptical of the UK’s trickle-down proposal, calling the idea of big cuts, geared particularly for the benefit of wealthier individuals and businesses, a “mistake.”

Truss and Hunt aren’t out of the woods yet, though.

The UK government is promising to keep subsidies in place through April 2023 to help cap how much consumers pay for energy as costs have risen to exorbitantly high levels. But after that, it’s unclear what’s next.

All eyes on Xi

Chinese leader Xi Jinping is expected to soon secure an unprecedented third term as head of the Communist Party. As CNN Business’ Laura He notes, Xi now faces many big challenges ahead to get the Chinese economy back on track.

China’s stringent zero-Covid policy has not stopped the pandemic from hurting growth. Youth unemployment is skyrocketing, and the lockdowns due to Covid have also led to more social unrest.

All the while, China’s housing market is in the midst of a meltdown. And there are growing concerns about how China’s continued crackdown on large companies and wealthy individuals could hamper the economy even further.

In perhaps an ominous sign, China announced Monday that it was indefinitely delaying the release of GDP and other economic data this week.

Up next

On tap this morning:

Earnings from Johnson & Johnson, Goldman Sachs, Lockheed Martin, Truist, State Street and Hasbro

Coming after the close:

Earnings from United and Netflix

Due Wednesday:

US housing starts; UK and Europe inflation; earnings from Procter & Gamble, Travelers, Baker Hughes, Tesla, IBM and Alcoa

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