Corporate Profits' New Enemy Is the 'Dollar Vortex'

In 2018, the U.S. dollar jumped in value by more than 10% from low to high, wreaking havoc with the profits of many major U.S. corporations. “That’s a fast move and a big move, and there’s always a lag for it affecting the economy,” as Jim Paulsen, chief investment strategist at Leuthold Weeden Capital Management, told Bloomberg. “When you increase the dollar, overnight you change the competitive status of American products," he added.

Among the companies taking particularly big hits recently were International Business Machines Corp. (IBM), Johnson & Johnson (JNJ), United Technologies Corp. (UTX), and Stanley Black & Decker Inc. (SWK). Key features of the "Dollar Vortex," Bloomberg's play on the record cold "Polar Vortex," are summarized below.

The U.S. Dollar's Damage

• ICE Dollar Index was up 10% from Feb. low to Nov. high in 2018
• Average level in 4Q 2018 was 3% higher than same period in 2017
• Earnings of North American companies reduced by $11.8 billion in 3Q 2018
• Earnings hit in 3Q 2018 was 12 times greater than in 2Q 2018

Source: Bloomberg

Significance for Investors

As the dollar rises in value versus other currencies, exports from the U.S. that are priced in U.S. dollars become more expensive to overseas buyers. The volume of shipments thus tends to drop, reducing export sales revenue. Also, revenues and profits earned by overseas divisions and subsidiaries of U.S.-based companies get translated into fewer dollars.

On the other hand, a rising dollar is good news for U.S. companies that import goods and services. Their costs will decline as a result. Retailers that sell imported products to U.S. consumers will be able to stimulate demand by cutting prices, or may keep prices steady and enjoy higher profit margins.

Overall, however, a rising dollar tends to be a negative for U.S. corporate profits, according to Jonathan Golub, chief U.S. equity strategist at Credit Suisse Group. He estimates that each move of 7 to 8 percent in the value of the dollar sends U.S. corporate profits in the opposite direction by 1%, per Bloomberg.

Of course, the degree of exposure varies greatly across companies. The same report notes that both IBM and Johnson & Johnson rely on markets outside North America for roughly half their revenues. In the fourth quarter, the rising dollar sliced about $500 million off IBM's sales, and negated nearly all overseas revenue growth for J&J. Additionally, industrial conglomerate United Technologies and toolmaker Stanley Black & Decker also noted that unfavorable exchange rate fluctuations were major headwinds for profits.

Other companies with large international sales have issued warnings about the negative impacts of a strong dollar in 2019, Bloomberg adds. Among these are drugmaker Pfizer Inc. (PFE), chemical giant DowDuPont Inc. (DWDP), and fast food chain McDonald's Corp. (MCD).

Largely based on expectations of an economic slowdown, the median forecast among Wall Street strategists is that the dollar will fall by about in 5% in 2019, per Bloomberg. However, currency strategists at HSBC Securities and the Royal Bank of Canada are among those predicting that the dollar will continue rising this year.

The recent turn toward a dovish stance on interest rates by the Federal Reserve should exert some downward pressure on the dollar. Overseas bond investors are one source of demand for the dollar. As the yields on dollar-denominated bonds become less attractive versus the yields on bonds issued in other currencies, demand for the dollars needed to buy the former slips.

Looking Ahead

Decelerating worldwide economic growth and the unresolved U.S.-China trade war already are big negatives for the U.S. corporate profit outlook. Continued strengthening of the dollar would add to those woes, but expert opinion is divided on its direction.