European issues dominated client conversations last week, according to the recent US Weekly Kickstart report from Goldman Sachs, and they will have an impact on US stocks.
ECB’s bond purchases in discussion among hedge fund managers
Sovereignty issues, from Russia’s invasion of Ukraine, to ECB bond purchases to the upcoming Scottish independence vote on September 18, all became issues of discussion among hedge fund managers. The Goldman Sachs report says that the ECB “surprised markets” by cutting rates and announcing an asset backed purchase program, but as reported in ValueWalk, other firms, including Barclays Bank, had anticipated the move.
After the announcement, Goldman Sachs now attaches “a 30% possibility to an ECB QE program targeting European sovereign bonds,” the report noted. “Inflation prospects will be the determining factor.”
Euro vs Dollar
In terms of the Euro currency, the investment bank suggests US Dollar could appreciate by more than 20 percent and that the currency pair could reach parity by 2017, driving a major trend in the currency. Supporting this is what Goldman sees as strong US growth, which they see as near 3 percent over the coming years, against mediocre GDP growth in Europe of below 2 percent. “In contrast with a strengthening USD and Fed rate hikes on the horizon, continued ECB accommodation drives portfolio flows to hunt for yield outside the Euro area.”
While the relationship between the euro and dollar signals the start of a major trend, Goldman says it is economic growth, not currency trends, that will be the key driver of S&P 500 earnings.
Changes in dollar strength to have marginal implications for S&P 500
Goldman’s financial modeling incorporates economic growth, inflation, oil prices, interest rates, and the dollar into a top-down projection of S&P 500 sales, margins, and earnings. Of these model inputs, “changes in dollar strength have only marginal implications for S&P 500 fundamental growth,” the report said, noting that FX moves often have offsetting effects on revenues and margins. Typically a higher currency has a negative impact on exports in a nation, but Goldman says this will be negated in the US by corporate currency hedging to reduce the impact. “World GDP is a much more significant factor than FX, so the impact of ECB actions on economic growth, rather than on currency strength, will carry consequences for US corporate profitability.”
US dollar to least impact small cap stocks
Unlike Barclays, who sees a strengthening Eurozone and a weakening US economic climate, Goldman recommends investors purchase a portfolio of the most domestic facing S&P 500 stocks. Goldman says a strengthening US dollar would least impact small-cap US stocks, which rely more on domestic sales, than US large caps, many with international exposure. “Because roughly 80% of Russell 2000 sales are derived domestically compared with 67% for the S&P 500, small-caps are more insulated from changes in currency strength and foreign economic growth.”