The surging dollar will separate the winners and losers this earnings season

• The US dollar is at multiyear highs as investors prepare for the possibility of more inflation.
• Morgan Stanley says the dollar strength will clearly separate the winners and losers of the upcoming earnings season.
• Stocks with high foreign sales exposure are most at risk of disappointing.

A soaring US dollar is likely to separate the winners from losers this upcoming earnings season, according to Morgan Stanley chief US equity strategist Mike Wilson.

The dollar index, a measure of the US currency against a basket of international counterparts, hit its highest in more than two years after an unexpectedly hot December jobs report. The greenback has tracked US Treasury yields higher on the expectation that Donald Trump's proposed policies will lead to higher inflation. That, in turn, could necessitate tightening, not further easing.

Wilson says such a strong dollar typically makes for higher dispersion during earnings season. In other words, outsized wins for some stocks, and bigger losses for those with the most foreign sales exposure.

"This typically drives a wider range of performance outcomes across the index during reporting season and fosters a robust stock picking environment," Wilson wrote in a Monday note.

He added that the relative performance of stocks with low versus high dollar sensitivity to earnings-per-share has accelerated as the dollar has strengthened since September.

Wilson says it thus makes sense to favor stocks with relatively low foreign sales exposure and low sensitivity to a stronger dollar, like telecom services and utilities.

"This cohort has begun to outperform on a relative basis since the dollar started to strengthen in October, and we see outperformance continuing as earnings season progresses," he wrote.

Meanwhile, sectors with the biggest foreign exposure — like household products, food and beverage, and technology hardware stocks — are likely most at risk, he said.

He added, however, that a stronger dollar likely won't impact overall performance at the index-level, so long as the dollar's upside is driven primarily by robust domestic growth.

"Dollar strength is likely less of a determinant of earnings results at the index level and more of a factor at the stock level given that foreign sales exposure varies widely across the index," he said, adding the index's overall foreign revenue exposure is less than 30%.

Wilson's team expects a "mid-single-digit" earnings-per-share beat rate at the index level this earnings season.