The surging value of the U.S. dollar may be posing the biggest threat to U.S. corporate earnings since the 2008 financial crisis, hurting results at most U.S.-based multinationals. Some on Wall Street are even talking about an earnings recession.
The dollar’s gain of 22 percent in the past 12 months against a basket of major currencies has landed a double whammy on U.S. companies with big sales abroad. Revenue and earnings from foreign markets are worth less when translated into greenbacks and their costs become relatively less competitive against rivals producing in countries with declining currencies.
Dollar moves of this magnitude in the past have resulted in what Bank of America/Merrill Lynch strategists term an "earnings recession," which is generally defined as at least two successive quarters of declining earnings from the year-earlier quarters. The brokerage says that a 25 percent gain in the U.S. dollar in a 12-month period has historically coincided with a 10 percent decline in the market's earnings per share.
That hasn’t happened yet - but the downward trend is clear. Wall Street analysts currently estimate earnings growth of 1.3 percent for 2015, down from a forecast of 8.1 percent at the beginning of the year, according to Thomson Reuters data. The S&P 500's earnings per share are expected to drop 3.1 percent in the first quarter and 0.7 percent in the second quarter before recovering modestly in the second-half of the year.
Nearly one-fifth of S&P 500 companies have warned on earnings for the first quarter, with at least 49 companies mentioning the effects of the dollar on results, according to Thomson Reuters.
"This is just the beginning," said Richard Bernstein, veteran Wall Street strategist and now CEO of Richard Bernstein Advisors in New York. "This impact of the dollar on U.S. earnings could last for three to seven years. It may not happen every quarter but there's a secular risk to U.S. earnings, primarily to multinationals, as the dollar appreciates."
Expectations for S&P 500 earnings are expected to keep falling as companies tally the dollar impact on results in the next few weeks.
Take chemicals producer DuPont (DD.N), for example. On Jan. 27, the company forecast full-year earnings of $4.00 to $4.20 for 2015 after a 60-cent negative drag from the dollar, based on its level on Jan. 23.
Since that time, the dollar index .DXY, which measures the dollar against six different major currencies – the euro, yen, pound, Swiss franc, Swedish krona and Canadian dollar - has gained nearly 3.5 percent. Jefferies analyst Laurence Alexander estimated in a March 11 note that DuPont's currency hit for 2015 earnings will be an additional 5 to 10 cents. Dupont, whose quarterly results are due on April 21, declined to comment.
The Federal Reserve on Wednesday lowered its expectations for U.S. economic growth and inflation over the next two years in what was widely seen as an acknowledgment that the soaring dollar has stalled its plan to start raising interest rates.
That temporarily arrested the dollar's sharp gains, but many strategists see the greenback continuing to rally, with Goldman Sachs predicting the euro will fall more than 10 percent in the next 12 months to $0.95 from $1.082 late on Friday.
International revenues account for about one-third of S&P 500 sales, according to Goldman Sachs data, and more than 40 percent for technology, materials, energy and industrial companies.
The dollar’s gains are a boon for rivals in Europe and elsewhere that have more of their costs in currencies, such as the euro, that have declined and will get the translation benefits from dollar sales.
For instance, European aircraft maker Airbus Group NV (AIR.PA) could eventually see an improvement in margins as it translates dollar revenues back into euros. Its hedging of sales at a much lower dollar exchange rate will, though, delay the full impact for years. The company may also have room to price more competitively to win major contests against rival Boeing (BA.N), though it may prefer to focus on boosting profits rather than increasing market share.
Big companies warn
North American public companies could give up more than $25 billion in revenues in the first quarter alone, because of currency-related volatility, said Wolfgang Koester, chief executive of FiREapps, a foreign exchange data analytics firm in Phoenix, Arizona. The fourth-quarter effect was about $18.66 billion, according to Koester.
Among those that have warned are technology giant IBM (IBM.N), semiconductor maker Intel Corp, apparel retailer Michael Kors (KORS.N), fashion accessories company Fossil Group (FOSL.O), and industrial conglomerate Honeywell (HON.N), all of which have said results would be hit by currency issues.
Companies have been rushing to increase their protection against further dollar strength through increased hedging, though that adds to costs and if mismanaged can create risks of its own.
“We have seen a huge increase in the number of our clients that are hedging – they have doubled or tripled. We have also seen a huge increase in the percentage of their exposure that they're hedging,” said David Pierce, director of business development at GPS Capital Markets, a Salt Lake City-based corporate FX brokerage firm that helps clients hedge currency exposure.
While hedging helps multinational companies navigate volatile currency markets, most don't hedge 100 percent of their exposure. Also, badly designed or ill-timed programs can end in disaster, such as in 2008, when Brazil's pulp and paper manufacturer Aracruz lost more than $2 billion betting that the Brazilian real would continue to gain in value. Instead, the currency plunged against the dollar.
The dollar’s strength is a particular problem for companies with exposure to Latin America. A massive effective devaluation of Venezuela's bolivar has hurt companies including tissue and diaper maker Kimberly-Clark Corp (KMB.N) and Ford Motor Co (F.N), which have had to sharply discount the value of their assets in Venezuela. And the weakness of the real and the Mexican peso will only add to issues in those markets.
Companies who sell almost all their goods and services within the United might be the best hiding place against the impact of a strong dollar. A Goldman Sachs basket of domestic U.S.-focused companies has gained about 22 percent in the last 12 months, compared with a 13 percent rise for the S&P 500.
Omar Aguilar, chief investment officer of equities and multi-asset strategies for Charles Schwab Investment Management in San Francisco, said investors have likely factored in the dollar's strength into this quarter's reports, but they should prepare for more negative effects over the rest of the year.
"It will have a bigger impact going forward. I expect the impact on third-quarter earnings to be much more dramatic," he said.