Strong dollar forecast to wipe $10bn off US company earnings in Q3

Sunday, Oct 30, 2022

By News Desk

New York: The rapacious rise of the dollar is set to wipe more than $10bn from US corporate earnings in the third quarter, analysts estimate, piling pressure on companies that are already grappling with high prices and a gloomy domestic outlook.

The dollar’s strength has been eating into US earnings all year, taking its toll on makers of everything from children’s toys to cigarettes. The trend is becoming increasingly difficult for investors to ignore as concerns grow about its knock-on impact on demand.

“As an investor you’re trying to get clarity — is what I’m looking at a translation problem or a demand problem?” said Jack Caffrey, a portfolio manager at JPMorgan Asset Management.

The translation problem refers to the way a stronger dollar reduces the relative value of sales made in foreign currencies when they are converted back into dollars for quarterly financial reports. Measured against a group of other developed-market currencies, the dollar rose 17 per cent in the first three quarters, reaching its strongest level in more than 20 years.

Jonathan Golub, head of US equity strategy at Credit Suisse, estimates that for each 8 to 10 percentage point rise in the dollar index, these translation effects knock 1 percentage point from earnings per share across the S&P 500.

With estimated earnings of $480bn before earnings season kicked off, this year’s move would cut third-quarter profits by around $10bn. Some investors estimate the translation effects could be even higher. Michael Walker, portfolio manager at AllianceBernstein, suggested this year’s move could wipe around 3 per cent from profits across the index 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 slashed its revenue forecasts by around $500mn earlier this year, for example, its stock recovered from a brief blip to close the day in positive territory.

More concerning, however, is the potential for demand to fall as rivals that produce and sell in weaker currencies now look cheaper.

“It’s not something people have talked about enough over the last several years, so there may be an unfortunate period of time where [companies] have to recalibrate what information comes through,” added Caffrey.

AllianceBernstein’s Walker contrasted Microsoft with its megacap rival Amazon. Although both are based in California, Microsoft sets prices for its Azure cloud service in local currencies, while rival Amazon Web Services prices in dollars.

“With currencies deviating this much, it would seem to me a big competitive advantage for Microsoft, which is taking a big translational hit but is choosing not to raise their prices. Whereas Amazon is effectively raising prices for their customers.”

Moreover, one key reason for the dollar’s recent strength is the brighter economic outlook in the US compared with many other countries, meaning demand may fall even without additional competition.

When Levi Strauss reported second-quarter earnings in June, the company took a translational hit from the strong dollar but stressed that it still had “strong momentum” in Europe. By the time it reported third-quarter results and another foreign exchange hit earlier this month, however, chief executive Charles Bergh said its European wholesale customers were “being cautious” and predicted further weakness “as the winter begins to hit”.

Goldman Sachs’ index of companies that generate the majority of their revenues in the US fell by 15 per cent in the first three quarters, compared with a 30.5 per cent decline in its index of companies with a large international presence over the same period.

Besides a slightly less bleak economic outlook in the US, the dollar’s strength has been encouraged by rapidly rising US interest rates. While the dollar has fallen from its highs in late September as investors have bet on a slowdown in the Fed’s interest rate increases, a meaningful weakening of the dollar is unlikely until the Fed actually begins cutting rates. The central bank has signalled it is not prepared to do so until inflation reaches its 2 per cent target.