My word-find function has been going into overdrive this earnings season, looking for a few key phrases in earnings-call transcripts: “Foreign exchange.” “Currencies.” “Dollar.”
Netflix (NFLX) Chief Financial Officer Spencer Neumann summed it up succinctly in his company’s conference call: “The FX drag is significant.”
The rise of the U.S. dollar, spurred by the Federal Reserve’s interest-rate increases, among other factors, is triggering quite the knock-on effect to corporate profits. While investors might want to strip out currency impacts to get a better idea of fundamental demand, they should also prepare for these hits to last a while.
In a report this week titled, “King Dollar Has More Room to Gain,” Wells Fargo strategist Erik Nelson cited multiple drivers for continued dollar strength, including the currency’s traditional resilience at times of market stress.
“The dollar index can continue to rally here,” Chris Vecchio, senior strategist at DailyFX, told Yahoo Finance Live earlier this week. “To use an old axiom, the dollar remains the nicest house in a bad neighborhood.”
That is, while the U.S. economy may be slowing and even entering a recession, many other global economies are faring worse. In currencies, it’s all relative.
That dollar strength is costing companies. Citi strategists estimate that a 10% bump in the dollar index will cut $15 to $20 from S&P 500 earnings per share. The dollar index has rallied more than 17% this year versus a basket of currencies. The greenback is up 14% versus the euro, and a whopping 30% against the Japanese yen.
This early earnings season is littered with examples of the ensuing costs. IBM numbers beat estimates, even as the company said currency translation cost it $1.1 billion last quarter. Netflix’s operating margin dropped to 19.3% from 23.5% last quarter — a decline it blamed almost entirely on the dollar’s gain. And Procter and Gamble will take a $3.9 billion, after-tax hit from currency effects this year.
Large companies do have the ability to hedge, or offset, the gains in the dollar in various ways, including covering expenses in local currencies. But the dollar’s move has been so big and so rapid this year that even the most seasoned hedgers have had difficulty adjusting.
It’s also tough for corporations to predict the dollar’s move six months to a year to even 18 months ahead, as they would need for hedging, Jefferies Managing Director and Head of Corporate Hedging and FX Solutions Joseph Lewis told Yahoo Finance Live recently: “The hardest part for companies right now to determine is, will this persist? You can take 10 economists — they’ll say slightly different things, have slightly different forecasts. I think that’s been really challenging for my clients; there isn’t a consistency in view.”
So, what are investors to do when it comes to factoring in the effect of the dollar? The bottom line for Citi’s Scott Chronert: “USD relevant for equities but not the main driver,” he wrote in a recent note. Rather, he said, investors should focus on “underlying business trends and conditions.”
Investors have another option, as Yahoo Finance’s Jared Blikre pointed out in Wednesday’s Morning Brief: They can invest in small-cap companies, which generally have less exposure to currency fluctuations than large cap companies.
