Download Report

January 28, 2015
Market Update
U.S. Corporations and Equity Markets Can Survive the Strong Dollar
Rebecca Patterson, Chief Investment Officer
•
U.S. equity markets fell sharply Tuesday in large part on corporate earnings disappointment,
in turn tied to the strong dollar
•
We expect the dollar to continue appreciating this year; while it is a lingering headwind for
multinational U.S. companies, we see four reasons why the dollar will not undermine U.S.
equities on a sustained basis: the pace of dollar gains should moderate, corporate hedging
programs will become more aggressive, overseas demand should improve and help U.S.
earnings, and equity markets will quickly discount this headwind as a consensus view
•
We remain comfortable with our current equity positioning: overweight equities broadly
with a bias towards U.S. large-cap stocks and currency-hedged where possible on nonU.S. equities (particularly euro-denominated)
For the last few decades, U.S. Treasury secretaries
have shared a mantra: “A strong dollar is in the
interest of the U.S. economy.” There is a lot
of common sense to the statement, as a strong
dollar increases Americans' purchasing power
and helps control inflation, which in turn allows
the Federal Reserve to keep borrowing costs
relatively low. That’s all good for growth.
Especially over the last few decades, though, as
companies have become more global and have
sourced revenues from an increasing number of
countries, the “strong dollar” mantra has become
more complicated. If a company is not adequately
hedged (corporate treasury departments usually
try to “neutralize” foreign exchange translation
for earnings through hedging programs), weaker
foreign currencies can hurt the firm’s revenues
when it reports in U.S. dollars.
That’s exactly what happened Tuesday. A number
of high-profile, large U.S. corporations – ranging
from Procter & Gamble to Microsoft to Pfizer
- highlighted the damage they incurred from a
strong dollar in the latest quarter, with several
suggesting more pain could come throughout
2015. Partly in response, the S&P 500 fell more
than 1.3% on the day.
We expect more of the same this earnings season,
for two reasons. First, most corporations hedge
using consensus forecasts. For the euro/dollar
exchange rate in particular, moves over the last
several months were much more dramatic than
what the consensus had expected. As a result, we
believe that a number of U.S. firms will have found
themselves “under-hedged” and with subsequent
hits to their quarterly numbers. Second, we believe
that many corporate executives use the earnings
season as a way to guide investor expectations,
with a bias to under-promise and over-deliver.
In the current environment, for an executive to
say that the dollar could hurt a firm for the year
ahead will not make that company stand out as
“failing,” since so many multinational firms will
likely be in the same boat. Earnings estimates
for the S&P 500 for calendar 2015 have fallen
3.3% year-to-date. The energy sector appears
responsible for almost 70% of that reduction,
though it comes as no surprise that tech and
Market Update: U.S. Corporations and Equity Markets Can Survive the Strong Dollar
industrials, two internationally exposed sectors,
contributed to roughly 20% of the decrease in
overall S&P 500 earnings estimates.
Looking ahead, we believe the dollar will
strengthen further. Despite a 17% gain in the
trade-weighted dollar since last June, the currency
remains well below longer-term historic averages.
Support should come as well from an improving
U.S. balance of payments and continued widening
in differentials between interest rates in the U.S.
and overseas (note the 10-year U.S. Treasury
yield today stands just under 1.8% versus 0.37%
in Germany and 0.28% in Japan).
Additional dollar strength is certainly not good
news for large U.S. multinationals. But we believe
it will be much less of a headwind in the quarters
to come than it is now, for four reasons.
1. Fewer currency surprises. When currency
trends are gradual, it is easier for corporations
to adjust businesses, broadly as well as
currency hedging in particular. Given how
far some of the major currencies have fallen
already versus the dollar, we see less risk
that continued dramatic currency moves
continue. As an example, the euro has lost
some 18% against the dollar just since last
May, more than double the average annual
(absolute) change of 8.5% since 1999, the
year the euro was launched. As of Jan. 28, the
end-2015 consensus EUR/USD forecast was
1.12, with a forecast range of 0.96 to 1.14.
Three months earlier, that same end-2015
forecast had been 1.20, with a range of 1.10
to 1.35. For corporations to be truly caught
off guard, the euro would need to weaken
significantly beyond these new more bearish
expectations, and quickly. While possible, it
is not our base case.
2
2. Corporations are dynamic. Over the last
few decades, as companies have grown more
global, their treasury departments have
become more sophisticated; in many cases,
large U.S. multinationals employ entire
teams dedicated to managing currency risk.
In general, currency values and positioning
are evaluated daily, with changes to hedging
programs made regularly. One common
approach used by large firms is to hedge the
bulk of currency risk (as high as 75% or
100%) for the coming quarter, with less risk
hedged the further the company goes out in
time. The idea here is that firms can’t know
with much conviction what a currency might
do over the coming two or three years, but
could have at least an educated guess looking
at the next quarter or two. After this latest
dollar “shock,” it is reasonable to assume
that a number of companies have added to
hedges to reduce further risk to their USDbased revenues. That means that, as we look
forward, the negative currency surprise each
quarter should become more muted.
3. Weak foreign currencies are helping demand.
Central banks overseas are easing monetary
policies and weakening their local currencies
to spur growth – so far this month, eight
central banks have announced easier policy,
with the European Central Bank taking
center stage. That’s clearly good news for
U.S. companies selling their products or
services abroad. While monetary easing feeds
through to economic growth with a lag, there
are at least some early signs that U.S. firms
might see some benefit in the quarters to
come. Germany is a good example – exports
account for about half the country’s GDP,
so a weaker euro is great news for exporters
and broader business confidence. Over
time, that also feeds through to consumer
Market Update: U.S. Corporations and Equity Markets Can Survive the Strong Dollar
confidence and spending. Just this week,
Germany released its January Ifo business
sentiment index, which rose for the third
consecutive month. Together with other
recent business confidence surveys, the Ifo
suggests German GDP rising at just above a
1.5% annualized pace at the start of this year,
a nice improvement from growth well under
1% in recent years.
4. Bad news is getting priced in quickly.
The selloff in U.S. equities Tuesday was
certainly led in large part by dollar-related
disappointment. As a rule, markets react
to what’s not priced in – they react to
surprises. As the strong dollar headwind is
increasingly understood and discounted into
earnings estimates, it should become less of a
market driver.
Hiding in smaller-cap U.S. equities with less
international exposure, in our view, is not an
easy solution given their richer valuations and
less liquidity than large-cap peers. While we
hold some small- and mid-cap equity exposure,
we remain comfortable with our bias towards
large-cap U.S. equities along with our (mostly)
currency-hedged overseas equity exposure.
Investors should not extrapolate from Tuesday’s
earnings news and the subsequent market storm.
We see calmer weather ahead, helped not just
by an improving U.S. economy but by dynamic
corporations and markets, as well as growthsupportive monetary policy globally.
This material is for your general information. It does not take into account the particular investment objectives, financial situation, or needs of individual
clients. This material is based upon information obtained from various sources that Bessemer Trust believes to be reliable, but Bessemer makes no
representation or warranty with respect to the accuracy or completeness of such information. Views expressed herein are current only as of the date indicated,
and are subject to change without notice. Forecasts may not be realized due to a variety of factors, including changes in economic growth, corporate
profitability, geopolitical conditions, and inflation. The mention of a particular security is not intended to represent a stock-specific recommendation, and
our view of these holdings may change at any time based on stock price movements, new research conclusions, or changes in risk preference.
Atlanta • Boston • Chicago • Dallas • Denver • Greenwich • Houston • Los Angeles • Miami
Naples • New York • Palm Beach • San Francisco • Seattle • Washington, D.C. • Wilmington • Woodbridge
Cayman Islands • New Zealand • United Kingdom
Visit us at www.bessemer.com.
Copyright © 2015 Bessemer Trust Company, N.A. All rights reserved.