The Strong Dollar’s Impact on Corporate Earnings:
What Investors Should Know
By Vaughn Woods, CFP, MBA
As we enter the latest earnings season, investors should be aware of a crucial factor that could significantly influence corporate performance, the strength of the U.S. dollar. Tariffs, planned to be put in place by the Trump administration, are expected to initially create an inflationary economic climate and only later reduce inflation. Historically, periods of dollar strength have been associated with a lower frequency of companies beating revenue expectations. This relationship suggests that we may see fewer positive surprises in sales forecasts this quarter compared to the previous one.
The Dollar-Earnings Connection
The U.S. Dollar Index (DXY) has shown considerable strength recently, appreciating by 2% in the third quarter of 2024. During that period, 42% of companies reported positive surprises in their sales forecasts. However, as the dollar continues to strengthen, analysts anticipate this percentage may decrease in this current reporting season.
Why does dollar strength matter for corporate earnings? When the U.S. dollar appreciates against other currencies, it can have several effects on multinational companies.
- Reduced foreign earnings: A stronger dollar means that foreign revenues translate into fewer dollars when repatriated, potentially lowering reported earnings.
- Pricing pressure: U.S. goods become more expensive in foreign markets, potentially reducing demand and sales volumes.
- Competitive disadvantage: Foreign competitors may gain an edge in pricing, potentially eroding market share for U.S. companies.
What to Expect This Earnings Season
Given the historical relationship between dollar strength and revenue beats, investors should adjust their expectations for this reporting season. Here are some key points to consider:
- Lower frequency of positive surprises: We may see fewer companies exceeding consensus sales forecasts compared to the 42% that did so in Q3 2024.
- Sector-specific impacts: Industries with significant international exposure, such as technology, consumer goods, and industrials, may be more affected by dollar strength.
- Increased earnings dispersion: Dollar strength typically leads to a wider range of performance outcomes across the index, creating opportunities for selective stock picking; that is, our core competency.
Strategies for Investors
While a stronger dollar presents challenges, it also creates opportunities for savvy investment selection. Here are some strategies we are considering.
- Domestic-oriented companies: Firms with primarily U.S.-based revenues may be less affected by currency fluctuations.
- Monitoring for natural hedges: Companies with costs denominated in foreign currencies may have some built-in protection against dollar strength.
- Sector rotation as a strategy: Sectors like utilities and telecommunications, which tend to have more domestic focus, may outperform during periods of dollar strength.
- Guidance: Companies may provide insights into how they’re managing currency headwinds, which can be valuable for assessing future performance.
- Quality: Strong companies with pricing power and efficient operations may be better positioned to weather currency challenges.
The Bigger Picture
While the strong dollar may present near-term headwinds for some companies, it’s essential to maintain a long-term perspective. Currency fluctuations are cyclical, and what presents a challenge today may become an advantage in the future. Moreover, dollar strength often reflects underlying economic factors that can be positive for the U.S. economy, such as higher interest rates or stronger economic growth relative to other countries. These factors can create a supportive environment for U.S. equities over the long term.
Conclusion
As we navigate this earnings season, the strength of the U.S. dollar will likely play a significant role in shaping corporate results. While we may see fewer positive surprises in revenue forecasts, this creates an environment where careful analysis and stock selection can potentially yield attractive opportunities. Of course, currency impacts are just one factor among many that influence corporate performance. By staying informed, diversifying appropriately, and focusing on companies with strong fundamentals, we hope to position your portfolio to weather short-term currency fluctuations. These short-term fluctuations can be driven by U.S. political stability compared to geopolitical tensions elsewhere. Market sentiment and robust U.S. economic growth, inflation and especially interest-rate differentials between countries can motivate investors to shift funds from Euros to U.S. dollars, increasing the demand for the dollar and causing it to appreciate.
Sincerely,
Vaughn Woods, CFP, MBA
Vaughn Woods Financial Group, Inc.
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Investors should be aware that there are risks inherent in all investments such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter are those of Vaughn Woods and Vaughn Woods Financial Group and may not reflect the views of Bolton Global Capital or Bolton Global Asset Management. The information provided is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0312.