Is A Strong Dollar Good or Bad?

Posted in: Economics, General, Stock Market, Thought of the Week

A large portion of revenues from U.S. based companies come from selling goods and services overseas. In fact, almost 25% of S&P 500 revenues come from Europe alone.

Companies with earnings overseas must convert them back to U.S. dollars (USD), which exposes them to the rise and fall in value of our currency. For example, if a U.S. company sells €50M in goods across the Eurozone in a three month time period, then that company must convert those Euros (EUR) to USD on their financial statements.

Therefore, companies often face “currency risk” when reporting quarterly earnings because exchange rates between currencies fluctuate over time. In the example above, if at the beginning of the time period the exchange rate is 1.3 USD for each EUR, and at the end of the three months the exchange rate moved to 1.2 USD per EUR, the firm will lose a portion of their earnings to currency. Here’s the math to see the actual impact:

€50M x 1.3 = $65M

€50M x 1.2 = $60M

Total Loss à $65M – $60M = $5M in lost earnings

The USD has risen in value relative to most other major currencies rather steadily over the last two years, and the impact of a strong dollar is beginning to scare traders who have a short-term focus on equity prices.

The concern is that a strong dollar will expose companies to currency risk and negatively impact earnings stated in USD, just as it did in the example above. Additionally, a strong dollar makes our exports more expensive than countries with weak currencies because foreigners must convert their currencies into fewer dollars to buy our goods (think about a Parisian booking a hotel room in NYC).

As a result, market pundits and the media have been intensely focused on reported earnings over the past two weeks because they want to see the true impact of a strong USD to corporate earnings. Those who are focused on the short term fear that this currency risk will drive down expectations for S&P 500 earnings for all of 2015.

There is no question that the strong dollar will impact earnings for those companies that rely on exporting their goods or those who are required to translated foreign earnings back to USD. In fact, several companies that have already reported earnings have confirmed that a stronger dollar caused their earnings to come in lower than expected.

However, our Investment Committee believes these concerns are inconsequential when compared to the benefits of a strong dollar for three key reasons:

  1. Consumer Driven Economy: The U.S. is a consumer-driven economy, where consumer spending represents 70% of our economic activity. Since we rely far less on exports when compared to countries like China, any weakness in exports will have a muted impact to overall economic activity. Additionally, a stronger dollar allows this consumer-driven economy to get more for every dollar and fuels stronger confidence.
  2. Demand Remains Intact: The strength/weakness of a currency is independent of the fundamentals of a company. Just because Apple has exposure to foreign currencies clearly does not impact the overall number of iPhones sold. Currency risk is a temporary hurdle for companies and bears no indication of deteriorating fundamentals.
  3. Hedging: Large corporations that sell in multiple countries often hedge their currency risk. Meaning, if a U.S. company estimates that they will sell €25 million of goods in 2015, they can use the Forex market to eliminate the risk that the dollar could get stronger.

The banter in the media will not end anytime soon so expect to hear more fear and panic from a strengthening dollar. But remember that a stronger dollar will not impede Apple’s ability to create new and exciting products, and it certainly will not stop a biotech company from making advances in cancer treatments that are revolutionizing treatments and extending life expectancies.

The bottom line is that a strong USD will most certainly weigh on company earnings in 2015, which will cause traders that utilize short-term strategies to push market volatility higher. However, it will have little negative impact to long-term investors and could even act as an economic tailwind as consumer purchasing power and confidence translate into more spending.

Read this week’s Thought of the Week to learn more about the effect of the dollar on our economy.

Click Here for the Weekly Thought

As an Investment Advisory Representative working in conjunction with Global Financial Private Capital (GFPC) we are provided weekly thoughts on what is happening in the economy and the market. Written by our investment committee at GFPC we find these thoughts to be informative and interesting.