The dollar’s strength has wiped billions of dollars off second-quarter sales for US companies, prompting many to cut their forecasts for the rest of the year.
The list of leaders who support several million or billionsdollar hits has grown by the day after the US currency rose to its highest level in 20 years this month, including IBM, Netflix, Johnson & Johnson and Philip Morris. That group is expected to grow as tech industry titans like Apple and Microsoft, which generate a substantial portion of their business outside the US, release quarterly results in the coming days.
The currency shock has clouded a period of gains that was being closely watched for signs of a weakening global economy as high inflation and tighter monetary policy weigh on business and consumer demand. Economic data is already indicating a decline in activity, as inflation reduces the real purchasing power of consumers.
“Even if the dollar rally were to stop here, the strengthening we’ve seen over the past 12 months would be enough to prompt further downgrades in earnings estimates on exchange rate headwinds alone,” said Max Kettner, strategist at HSBC.
The dollar has been buoyed by the Federal Reserve, with politicians in Washington rapidly raising interest rates in an effort to cool inflation, which hit a 40-year high in June. They are expected to deliver another huge rate hike next week and continue to tighten policy this year to curb demand, raising interest rates well above their counterparts in Europe and Japan. Higher interest rates often attract foreign investors, which increases the demand for the currency.
But American companies with big deals abroad are suffering because the strong dollar reduces the value of their international sales and makes them less competitive compared to local rivals. A slowdown in Europe and lockdowns in China designed to contain the spread of Covid-19 cases are also proving to be a thorn in the side of US companies with large overseas operations as demand dwindles.
Over the past week, IBM warned that a strengthening dollar could cut its revenue this year by $3.5 billion, including about $900 million in the second quarter. Johnson and Johnson cut your guide as the maker of Listerine mouthwash warned, the rapidly rising dollar could cut its sales by $4 billion this year. Currency carryover on cigarette maker Philip Morris eclipsed $500 million in the quarter; the streaming network Netflix, whose shows include drama Strange thingsestimated that he took a Sales hit of $339 million between April and June due to the strength of the dollar.
They join a long list of companies that had already raised the issue before the dollar reached parity against the euro, including Microsoft, Salesforce and Medtronic.
“The speed of the buildup is the sharpest we’ve seen in over a decade,” James Kavanaugh, IBM’s chief financial officer, said on the company’s earnings call. “All the currencies we cover, more than half of them are down double digits against the US dollar this year. So it’s a bit, I would say, unprecedented.”
Kavanaugh said IBM hedged about 35 of the more than 100 currencies it did business in. It was a response, coupled with the large currency shock, that left some investors “upset,” according to Diane Jaffee, a senior portfolio manager at TCW. IBM shares fell 5 percent after its results, even as the company outshone Wall Street expectations.
Big Tech is highly exposed to the dollar given the industry’s presence abroad. Goldman Sachs estimated that 59 percent of technology company sales in the S&P were generated outside the US. That’s well above the average for publicly traded large-cap US companies; the S&P 500 groups as a whole derived 29 percent of their $14 trillion in 2021 revenue from abroad.
“Some companies are struggling a little bit more than others with the dollar,” Jaffee said. “Although valuations have come down quite a bit in the tech sector, we still want to be very. . . judicious due to concerns about exchange rates and that affects tech companies even more than others.”
The returns have shown that investors are favoring the shares of companies doing business primarily in the United States. The Goldman index of US companies with large international exposures has more than doubled this year compared to its domestic counterpart, down 19.6% versus 9.1%, respectively.
For now, second quarter earnings remain strong; overall, they are expected to have increased 10 percent from the previous year. But that number could have been closer to 12 percent were it not for the effect of a strong dollar, estimated Jonathan Golub, head of US equity strategy at Credit Suisse. He said that every 8 to 10 percent rise in the dollar index knocked about 1 percent off the S&P 500’s gains.
“Earnings are coming in nicely, but imagine how much better they would be if the dollar wasn’t so strong,” Golub said.
The dollar’s effects on earnings are often slower than the actual change in the currency, so a strong dollar can be quoted for several quarters, even if dollar appreciation slows. Karl Schamotta, chief market strategist at Corpay, expects the dollar to peak now as many investors are betting the Fed will have to moderate its aggressive pace of rate hikes as the US economy cools.
“The big rally in the US dollar, especially relative to the euro and the yen, has had a big lagging impact on earnings that we’re likely to see for a couple of quarters,” Schamotta said.