Strong dollar wipes out $10 trillion worth of US companies
The strong dollar has been sweeping away corporate profits all year, taking in its wake companies that make children’s toys while hitting those that make cigarettes. The trend is becoming harder for investors to ignore as concerns grow about the impact this will have on demand.
“As an investor you’re trying to look for clarity — is what I’m looking for a translation problem or a demand problem?” says Jack Caffrey, a portfolio manager at JPMorgan Asset Management.
The translation problem refers to the way the strong dollar reduces the relative value of sales made in foreign currency when they are converted back into dollars for quarterly financial reports. When measured against a group of other developed nation currencies, the dollar has increased in value by 17% during the first three quarters, reaching its strongest level in 20 years.
Jonathan Golub, director of U.S. equity strategy at Credit Suisse, estimates that for every eight out of ten percentage points of increase in the dollar index, it has a 1% pass-through effect on earnings per share across all stocks. S&P 500 companies.
With earnings estimated at $480 billion before earnings season starts, this year’s moves could have wiped out three-quarters of the earnings, or close to $10 billion.
Some investors estimate that the translation effects could be even higher. Michael Walker, portfolio manager at Alliance Bernstein, suggested this year’s moves could wipe out about 3 percent of the index’s gains for the year.
Many investors are willing to look through such effects if they are confident in the underlying strength of a business. When Microsoft cut its earnings forecasts by $500 million earlier this year, for example, its shares rallied after a brief dip and were back in positive territory in just one day.
More worrying, however, is the potential for demand to fall as rivals that produce and sell in weaker currencies now have products that appear cheaper on the market. This is compared to the goods and services that are produced in the United States.
This is not something that people have talked about enough in recent years, so it could be an unfortunate period where companies have to recalibrate as information comes in,” added Caffrey.
AllianceBernstein’s Walker contrasted Microsoft with (mega-cap) rival Amazon, although both companies are based in California, Microsoft prices its Azure cloud services in local currencies, while Amazon Web Services prices in dollars.
“With currencies drifting and losing value against the dollar, it might seem like a competitive advantage for Microsoft, which is taking a big translational hit, but is choosing to raise prices, while Amazon is effectively raising its prices for its customers around world [due to the upward variations of the dollar]”.
However, a key reason for the dollar’s recent strength is the brighter economic outlook for the United States compared to other countries, which means demand in international markets could fall even without additional competition.
When Levi Strauss reported quarterly earnings in June, the company also had to take a transactional hit from a strong dollar but declared it still had “strong momentum” in Europe. By the time it reported third-quarter corporate earnings and another foreign currency shock hit the company this month, Chief Executive Officer Charles Bergh said it is Europe wholesale clients were “highly alert” and predicted further weakness as in which “winter begins to arrive on the continent”.
The Goldman Sachs index of companies that generate the majority of their profits in the United States fell 15 percent in the first three quarters of the year, compared with a 30.5 percent decline in the index of companies with a large international presence in the United States. same period.
Alongside a slightly less gloomy economic outlook in the US, the dollar’s strength has been buoyed by the rapid rise in interest rates by the Federal Reserve. While the dollar has fallen from its peak in September as investors have bet on a slowdown in the Fed’s rate hike, significant dollar weakness is unlikely until the Fed begins to cut interest rates. interest rates. The central bank has signaled that it is not ready for that until inflation reaches its two percent target point.
This week Apple predicted that foreign exchange impacts on its business could be even worse through the rest of the year, affecting about 10 percent of revenue for the coming quarter.
Apple’s chief financial officer, Luca Maestri, said the dollar was a “very significant factor,” noting that it has already increased its prices in some international markets to maintain its profit margins.
“At this point, to see any change in the dollar forecast, you would need to see the Fed make a change and we would need to see a series of month-over-month records of inflation losing its momentum,” said Mazen Issa, a strategist at TD Securities. “None of these things will happen soon.”
With information from the Financial Times.