A strong dollar wipes out billions of US corporate profits

The strong dollar wiped billions of dollars off US business sales in the second quarter, prompting many to cut their forecasts for the rest of the year.

The list of metrics that are recording hits of millions or billions of dollars has grown day by day after the U.S. currency hit a 20-year high this month, including IBM, Netflix, Johnson & Johnson and Phillip Morris. This group is expected to swell as tech industry titans such as Apple and Microsoft – which generate a substantial portion of their business outside the United States – release their quarterly results in the coming days.

The monetary shock clouded a period of earnings that was closely watched for signs of a weakening global economy, as high inflation and tight monetary policy weigh on business and consumer demand. Economic data is already signaling a decline in activity, with inflation reducing the real purchasing power of consumers.

“Even if the dollar’s rise were to stop here, the strengthening we’ve seen over the past 12 months would be enough to prompt further downward revisions to earnings estimates simply from currency headwinds,” he said. said Max Kettner, a strategist at HSBC.

The dollar was supported by the Federal Reserve as policymakers in Washington quickly raised interest rates in a bid to quell inflation, which hit a 40-year high in June. They are expected to deliver another giant rate hike this week and continue to tighten policy to restrain demand, raising interest rates well above their counterparts in Europe and Japan. Higher interest rates generally attract foreign investors, which increases demand for the currency.

But American companies with large businesses overseas are hurting as the strong dollar reduces the value of their international sales and makes them less competitive against local competitors. A slowdown in Europe and shutdowns in China designed to contain the spread of Covid-19 cases are also proving a thorn for US companies with large overseas operations as demand slows.

IBM last week warned that the greenback’s strengthening could slash its revenue this year by $3.5 billion, including about $900 million in the second quarter. Johnson & Johnson cut its forecast as mouthwash maker Listerine warned that the rapidly rising dollar could slash $4 billion from sales this year. Currency pressure on cigarette maker Philip Morris eclipsed $500 million in the quarter; Netflix streaming network, whose shows include dramas stranger thingsestimated it took $339 million in sales between April and June due to the strong 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 strengthening is the strongest we’ve seen in over a decade,” IBM Chief Financial Officer James Kavanaugh 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 that’s a bit, I would say, unprecedented.

Kavanaugh said IBM has hedged about 35 of the more than 100 currencies in which it does business. It was a response, coupled with the large currency hit, that left some investors “upset,” according to TCW senior portfolio manager Diane Jaffee. IBM shares fell 5% following its results, even as the company eclipsed Wall Street expectations.

Column chart of regional revenue distribution (%) showing that S&P 500 companies generated 29% of sales outside the United States in 2021

Big Tech is heavily exposed to the dollar given the industry’s overseas footprint. Goldman Sachs estimated that 59% of S&P technology company sales were generated outside the United States. This is well above the average for publicly traded large-cap US companies; S&P 500 groups as a whole earned 29% of their $14 billion in revenue in 2021 from overseas.

“Some companies have a little more trouble with the dollar than others,” Jaffee said. “Even though valuations have come down a lot in the tech sector, we still want to be very . . . judicious due to currency concerns that affect tech companies even more than others.

Returns showed that investors favor stocks of companies whose operations are primarily US-based. The Goldman index of U.S. companies with significant international exposures has more than doubled this year against its domestic counterpart, down 19.6% versus 9.1%, respectively.

Line chart of Goldman index performance of S&P 500 companies, broken down by regional sales exposure (%) showing that US companies with large international footprints have lagged in 2022

For now, second-quarter earnings remain strong – overall, they are expected to be up 10% from a year earlier. But that figure could have been closer to 12% had it not been for the effect of a strong dollar, said Jonathan Golub, head of US equity strategy at Credit Suisse. He said every 8-10% rise in the dollar index cuts about 1% from S&P 500 earnings.

“Earnings are coming in very well, but imagine how much better they would be if the dollar wasn’t so strong,” Golub said.

The effects of the dollar on earnings often lag the actual movement of 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 top now, as many investors are betting the Fed will have to temper its aggressive pace of rate hikes as the economy American is cooling.

“The big rise in the US dollar, especially against the euro and the yen, had a major impact on earnings that we’ll probably see over a few quarters,” Schamotta said.

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