Hedge funds can't stop betting on the stock market's secret weapon

The US dollar is already down almost 9% in 2017, bucking bullish expectations heading into the year. But can the greenback fall further?

Hedge funds think so. In fact, they’re the most bearish in three years.

That’s according to weekly data compiled by the Commodity Futures Trading Commission, which monitors the positions of large speculators. And it holds great significance for the US stock market, which has gotten an unexpected boost from a weaker dollar in the form of enhanced profit growth.

It’s a continuation of one of the year’s most surprising market storylines. Heading into 2017, the consensus was that President Donald Trump‘s pro-growth agenda would push the dollar higher. Then, amid doubts that Trump’s agenda would get done in timely fashion, the dollar’s fortune reversed, shocking just about everyone.

That’s resulted in an unexpected boost for US corporate earnings that were already the best in five years. A weaker dollar makes exports more profitable, which helps companies doing business overseas — most notably the multinational conglomerates with big weightings in stock indexes. And good, old-fashioned profitability has historically been the biggest driver of equity bull markets.

As such, the weaker dollar has been a secret weapon of sorts for stocks, helping to prop up earnings growth amid middling economic data and elevated geopolitical risk.

It’s possible that hedge funds and other large speculators are simply reacting to the dollar’s movements and adjusting positions accordingly, according Macro Risk Advisors. And they say it’s a strategy that may not end well, especially amid concerns that the short-dollar trade is getting too crowded.

“The positioning has roughly tracked the performance of the dollar, suggesting that trend followers may explain most of the positioning change in FX futures,” Pravit Chintawongvanich, the head of derivatives strategy at MRA, wrote in a client note. “If shorting the dollar truly is a crowded trade, a reversal in this trend could possibly spark a broader de-risking.”

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