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If “headwinds” was not already a hackneyed term in the lexicon of corporate America’s leaders, after six weeks of earnings announcements sullied by the recent strength of the U.S. dollar, it now surely is. 3M CEO Igne Thulin called the greenback’s comparatively high purchasing power a “tough headwind,” as U.S. products became more expensive abroad. Delta Air Lines President Ed Bastian remarked that “headwinds from the dollar strength” in their international segment were offset by stronger domestic market demand. “Currency and acreage headwinds” remain in 2015, Monsanto COO Brett Bergman told analysts on his company’s earnings call. Along with intense competition, American Express CFO Jeff Campbell listed “foreign exchange headwinds” and lower expected domestic growth as ongoing challenges. Several corporates, including UPS, an SNWAM portfolio holding, provided earnings on a “currency-neutral” basis to reassure (or to convince) investors that they were, in fact, still growing. CEOs collectively argued that the effects of the currency headwinds were a “financial reporting issue rather than an economic event,” as Aflac’s (another SNWAM portfolio holding) CEO explained in a press release. It is unusual, he argued, for corporates to repatriate the money they earn abroad (the question of why is a topic for another article, but a big reason, presumably, is tax). Since the dollar began its surge around the middle of last year, it is now 15% stronger versus a basket of other major world currencies. The Bank of America Merrill Lynch Corporate Master Index has nearly kept up, rising 11% over the same period. So, by this metric, a stronger dollar does appear to be merely a flesh wound.
A headwind for one company is necessarily a tailwind for another—take Toyota, for example. The weak Japanese Yen is helping generate a record number of sport utility vehicle sales in the U.S., creating a somewhat unexpected windfall for the automaker. Toyota now ships more autos to the U.S. than the next three largest Japanese automakers combined, Bloomberg noted recently, due to its increased focus on larger vehicles. A stronger dollar and correspondingly weak Euro is also benefitting companies in Europe. Sanofi, a French pharmaceutical firm, said that every 1% drop in the value of the Euro “should add 0.5% to earnings per share,” The Economist reported in late January. The question remains whether the aforementioned flesh wound will become more serious. At least one economist argues no. Writing for Project Syndicate, Barry Eichengreen of U.C. Berkeley contends in his article “Don’t Bet On A Stronger Dollar” that the market is already baking in all the factors (including superior U.S. economic growth, low unemployment, strong consumer sentiment and European and Japanese quantitative easing) that could sustain or make the dollar incrementally stronger. If labor participation, a better indicator of labor market conditions, Eichengreen says, rises, which he thinks is possible, wage pressure could drop, prompting the Federal Reserve to raise interest rates later than expected, a scenario that would not support further demand for U.S. currency.
As events play out, SNWAM portfolio holdings with international exposure may experience a temporary sting to their reported – keyword “reported” – bottom lines due to currency fluctuations, but we expect the overall quality of corporate credit to continue improving.
Sources: Project Syndicate, BAML Indices, Bloomberg, The Economist, company filings, SNWAM Research