Ok, the Dow is tanking but believe me these earnings numbers ain't just the recession and currency traders know it. I have, Bonddad has and others have blogged about the impact of the value of the dollar versus other currencies and the stock market.
I started with my diary on currency impacts on commodities. The point was that a declining dollar helped cause rising commodity prices. But now an improving dollar will trash Wall Street earnings.
Why? More below the fold:
Look at this article from Investor's Business Daily on Yahoo:
U.S. companies are relying more and more on overseas demand for profit and sales, a new report showed Wednesday, but the outlook for global growth has dimmed.
Foreign sales accounted for 45.8% of revenue last year, according to the half of S&P 500 firms that fully break out results, says Standard & Poor's. That's up from 43.6% a year earlier. Overseas revenue for the 251 companies surveyed climbed 12.5%, while domestic sales rose just 2.6%.
What does that mean?
Let's look at the impact of these revenue streams in a declining dollar and rising dollar scenario:
First declining dollar:
I have $1 in US revenue and 1 Euro in overseas revenue. The dollar last quarter was $1 per 1 Euro. The dollar now goes to $1.2 per Euro. MY US revenue still reports as $1 on my profit and loss statement as revenue. However, I sell my 1 Euro back now for $1.2 dollars. Voila, my income this quarter just went to $2.2 WITHOUT lifting a finger. Pretty cool, huh?
OK, but now let's look at the case of a rising dollar. I have the same $1 and 1 Euro. With the dollar a $1 per 1.57 Euroes (about where it was several months ago) I have $2.57 in revenue. But now the dollar drops to $1.28 per Euro. My earnings just went from $2.57 to $2.28 - that, BTW, is a 7.5% drop in earnings.
OK, with the statistics above, lets look at the impact on US earnings. In the past two years US companies had - call it - roughly 45% of their earnings overseas. The 50% increase in overseas earnings would translate to a 22.5% underlying growth in earnings (.45 times .5) for those companies. If the US currency rebounds to $1 per 1 Euro that 22.5% growth in earnings becomes a 22.5% drop in earnings.
So, yes, the recession will hurt earnings growth. But on top of that, the Fortune 500 is staring at a 10-12% or higher systemic drop in earnings due to dollar recovery. In a recession there is almost no chance these companies can grow "real" revenue to compensate for this "shadow" revenue drop.
So, expect the double whammy to be the gift that keeps on giving.
There is a silver lining here. In March I wrote Fed is killing US investment - do the math. It was basically an explanation for why a declining dollar kills investment in the US and lending in the US. The converse is true in a rising dollar; the best place to lend money right now - if you believe the dollar wil stay strong - is the US.
If I lend a Euro to the US at current rate (call it $1.25 per Euro) I can lend $1,250,000 for every 1,000,000 Euros I have. If I think the dollar is going to $1 per 1 Euro in two years, look at the math.
Lending to Europe:
Lend 1,000,000 today at 10% (let's pick a number)
In two years I have 1,210,000 Euros (simple interest)
Lending to US:
Lend $1,250,000 today at 2% (lower than Treasuries to make a point)
In two years I have $1,300,500 dollars
But if the dollar goes to $1 per 1 Euro, I now have 1,300,500 Euros - I have made more money lending at 2% in the US than lending at 10% in Europe. The run on US Treasuires may not be just a flight to safety but a very cheap currency arbitrage play.
So, with your head spinning, I stop.