A number of companies have blamed the strengthening dollar for disappointing fourth quarter and 2015 earnings guidance. With about 65% of S&P 500 companies having reported, headlines that around 75% of firms are beating expectations obscure the reality of forecasts that have steadily been marked lower. Growth for the quarter (year-over-year) is expected to be just 3%, while the full-year forecast now stands at just 5%. The strong dollar has certainly impacted profits, but generalizing about the impact is difficult as many factors come into play.
A company’s geographic revenue and cost mix affects the impact of currency movements as the dollar moves to varying degrees against different currencies. For example, US companies with large European revenues were impacted by the 4% appreciation of the dollar against the euro in the fourth quarter, but those with large Chinese sales were probably nonplussed about the 1% move against the yuan. Where costs are incurred can accentuate or mitigate the impact from currency fluctuations. Hedges also come into play. Some companies partially or fully hedged their offshore revenue for 2014, which flatters trailing results but lays the foundation for reversals in 2015.
A few examples from the fourth quarter reporting season illustrate these themes. Apple’s revenue during the period would have been roughly $2 billion higher without the dollar’s appreciation, but existing currency hedges softened the blow. In a similar vein, Google mentioned that currency movements erased $468 million from its quarterly profit, but hedges softened the blow by around $150 million. The IT sector derives almost 60% of its revenue overseas and thus is considered most vulnerable to the dollar’s rise, though some companies have differentiated products and have been able to raise prices in some markets.
Can we quantify the impact of the stronger dollar? J.P. Morgan estimates that a 12% rise in the trade-weighted dollar could hit profits by 4% to 6%, while Goldman Sachs has estimated that a 10% rise in the trade-weighted dollar could hit S&P earnings by $3. For context, the S&P is expected to earn around $116 per share in 2014. There may be room for further downside from here given that in January the dollar strengthened significantly against the euro (given the European Central Bank’s announcement) and also against currencies of other key trading partners like Canada.
The dollar is not the only factor negatively impacting earnings. Lower oil prices are expected to have caused energy sector profits to decline around 25% in the fourth quarter, and full year 2015 forecasts now call for a shocking 50% plunge. Results from the financial sector have also been weak, with a variety of headwinds cited, including reduced trading activity and lower levels of interest rates.
The flipside of US dollar strength making US equities less attractive is that cheaper currencies boost the appeal of less expensive equity markets like Europe and Japan. Looking at fourth quarter results in other markets, Japanese profit growth looks quite healthy and fiscal year 2015 profit growth of 11% should be well above that seen in the United States. Japanese firms earn almost 40% of their revenue overseas and have benefitted from the cheaper yen—though many also manufacture abroad and thus have seen rising costs. In Europe, quarterly earnings growth has also outpaced that of the United States, but hedges have dulled some of the impact and the euro has not weakened to the same degree against currencies in key emerging export markets. Still, European earnings are expected to grow around 7% in 2015, above the rate in the United States and reinforcing our positive take on this market. Relative valuations are the main driver of our current overweights to Eurozone and Japanese equities, but our confidence in this positioning is bolstered by the tailwind to earnings from currency depreciation.
Wade O’Brien is a Managing Director on the Cambridge Associates Global Investment Research team.