You Have Been Forewarned

Originally posted at Briefing.com

We've heard more than few pundits drive home the point that a stronger dollar is good for the stock market because it is a reflection of faith in the U.S. economic outlook. In that respect, the thinking goes that the dollar is in demand because the U.S. is where people want to invest. Maybe, though, the real case is that the dollar is in demand because the U.S. is where people are forced to invest.

Forced or not, the dollar's strength is a blessing and a curse.

It's a blessing because it holds down inflation pressure and makes it less expensive to travel overseas. It's a curse because it crimps earnings prospects for U.S multinational companies, makes it more challenging to sell products abroad, and creates vulnerabilities for the emerging markets by way of potential capital flight and dollar-denominated debt repayment angst.

In the coming weeks, we suspect we'll hear less about the blessings of a strong dollar and more about the curses (and maybe even some cursing) as companies shed light on their earnings results for the March quarter and their outlook for the remainder of the year.

Suspicious Minds

Our suspicions are rooted in the fourth quarter reporting period and specifically in the first half of that reporting period (January 20 - February 6) when many widely-held blue-chip companies checked in with their results.

During the aforementioned period, the U.S. Dollar Index traded between 93.00 and 94.76. It would eventually climb as high as 100.39 on March 13.

Those levels don't mean a whole lot in and of themselves, but when looked at in a broader time frame, they reveal that the currency headwind many companies were modeling for at the end of the December quarter grew even stronger as the first quarter progressed.

The U.S. Dollar Index saw a rapid appreciation (+6.6%) between late February and mid-March that surprised even many veteran currency traders. A 6.6% gain in a stock in that short amount of time is regarded as commonplace these days, but for a currency to move that much is quite extraordinary.

The intensity of the currency headwind is borne out in the fact that the average level of the U.S. Dollar Index in the first quarter of 2015 is 94.84 versus an average level of 80.08 in the first quarter of 2014.

Jingle Bells Not All Merry

Many companies of course employ hedging strategies to mitigate the impact of currency swings, yet it seems reasonable to argue that few, if any, hedges foresaw the rapid appreciation in the U.S. Dollar Index since July (+25%), let alone in the first quarter (+7.4%).

What that implies to us is that we are likely to hear a pickup in earnings warnings from multinational companies.

Oracle (ORCL) was the bell tolling for thee in that respect, yet there have been several other jingle bells too.

Oracle's fiscal year doesn't correspond to the calendar year. On March 17, it reported results for its fiscal third quarter ending in February. Revenues were unchanged at .3 billion, but would have been up 6% as measured in constant currency (i.e. excludes the impact of exchange rate fluctuations). Oracle added that the currency headwind to third quarter earnings per share was __spamspan_img_placeholder__.06.

On its conference call, it was acknowledged that "currencies continue to remain volatile." Consequently, the company said it is only providing its outlook in constant currency.

The aim here isn't to analyze Oracle's results, but to draw from them the example of how challenging it has gotten for companies to model the impact of exchange rate fluctuations. Moreover, it is clear that the dollar's strength is having an adverse impact.

Accenture (ACN) reported results for its fiscal second quarter ending in February on March 26. When providing guidance, it said its outlook for fiscal 2015 now assumes a foreign-exchange impact of negative eight percent compared with fiscal 2014 versus its previous assumption of negative five percent.

H.B. Fuller (FUL), a specialty chemicals company, had this to say about the dollar's impact when it reported its fiscal first quarter (Feb) results this past week: "the U.S. dollar is significantly stronger than we had originally forecast and this is negatively impacting the translation of our international results and in some cases creating margin pressure in regions where U.S. dollar-denominated costs are matched against revenue in non-U.S. dollar currencies."

In January H.B. Fuller was expecting fiscal 2015 organic revenue growth of approximately 6%. That forecast has now been lowered to approximately 2%.

When issuing a first quarter revenue warning on March 12, Intel (INTC) said it thought changes to demand and inventory patterns were driven in part by increasingly challenging currency conditions, particularly in Europe.

Apparel company PVH Corp. (PVH) presented a nice table in its fiscal fourth quarter earnings report detailing the year-over-year changes in average exchange rates between the dollar and a host of major currencies. It did so after noting that its fiscal 2015 EPS guidance of .75 to .90, excluding items, includes an expected negative impact of approximately .20 per share from foreign exchange rates due to the strengthening of the dollar against other currencies in which it transacts significant levels of business.

What It All Means

The companies mentioned above are just a trickle of what should be a stream of revenue and earnings growth warnings leading up to, and during, the first quarter earnings reporting period that are linked to the stronger dollar.

The strength in the greenback has been a function of trend growth in the U.S. economy looking better than that seen in most other major economies around the globe (which isn't the same as saying the U.S. economy is strong); however, the dollar zeal has been catalyzed by interest rate differentials that have foreign investors seeking higher yields in the U.S.

0.19% on the German bund or 2.0% on the 10-yr Treasury note?

A stronger dollar has its benefits, but they might be hard to see in the upcoming reporting period.

Be forewarned: the dollar's strength is apt to be cited increasingly for weak guidance.

That won't be a total surprise to this market, yet it could be a headwind of a different kind for this market if it drives earnings per share growth estimates for calendar 2015 into negative territory.

Related:
Sheraz Mian on Earnings and Why U.S. Investors Shouldn't Fear a Strong Dollar

About the Author

Chief Market Analyst