Strong Dollar Weakens Profits
By Mark Donnelly, CFA, MSF, CFP®
February 12, 2016
Oil prices are getting much of the blame for the recent U.S. stock market downturn,
but in reality a lower price for oil is a big net positive when so many companies and
consumers benefit from low energy costs. Another more likely culprit that has garnered
far less time in the media is the strong U.S. dollar.
The following chart shows how strong the dollar has become compared with a basket
of international currencies. It has appreciated almost 25% since mid-2014.
Economists will tell you that this represents a vote of confidence from the international
community in our economy. However, the other unfortunate side to this true story is
that when the dollar is strong internationally that also means that when American
companies sell their products outside of the U.S., the products are either priced higher
or the company has to discount the price to maintain pricing parity. At the same time,
the strong dollar reduces the conversion of profits abroad from foreign currencies into
dollars.
The strong dollar results in multi-national U.S. companies either losing sales because
of uncompetitive pricing versus foreign competitors, which reduces profits, or to remain
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competitive they reduce prices, which also reduce profits. Heads, large American
companies with significant business overseas lose, and tails—well, you get the idea.
In addition the lower conversion rate to transfer foreign profits back into the U.S. adds
to the short-term pain. Those large American companies most affected happen to
make up much of the Dow Jones Industrial Average and the Standard & Poors 500
index.
When you buy a stock, fundamentally what you’re buying is a claim on the company’s
current and future earnings and profits, which can be returned to you in the form of
dividends, or returned indirectly as the company invests to expand and grow which
can drive future profits higher and make the company (and its stock) even more
valuable. If earnings and profits decline temporarily, people regard those companies
as temporarily less valuable than they had been with higher earnings and profits. This
is why short-term traders pay so much attention to earnings season, when companies
disclose how much of their product their customers are buying and how much the
company made in the process.
The key word in all this is “temporary.” While oil prices seem to be stuck in the middle
of a glut, the speed of ascent for the value of the dollar may be slowing. That, in turn,
could reverse the earnings and profits slide of the past 18 months, and companies
could start to regain some of the value they’ve lost over that time period. Many of these
companies stocks could do what they always seem to do after declines: reverse
course and eventually test new highs.
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We hope this provides some perspective on the impact of a strong dollar on the
economy and a company’s earnings. If you would like to schedule a discussion about
your portfolio, contact your AEPG Financial Life Planner or Mark Donnelly at
[email protected] or at 908-821-9766.
Sources:
http://www.mauldineconomics.com/connecting-the-dots/the-dollar-dog-ate-corporateamericas-homework-6-casualties-of-the-strong-u
Bob Veres
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