Currency Headwinds Taking Center Stage

When we were leading up to earnings season, forecasted earnings reports were lowered several times. Now that we are in earnings season, it may be time to consider the outlook for earnings, and the impact on investors.

Here’s the issue:

• A surging U.S. economy causes the dollar to rise against foreign currencies, leading to:
• Weakening trends in Asia and Europe causes the Euro and Chinese renminbi to fall against the dollar, leading to:
• The rising price of goods from U.S. multinationals via their rising currencies causes revenues to fall, leading to:
• Declining earnings of U.S. multinationals like McDonald’s (MCD) or Boeing (BA) or Cisco (CSCO).

Note the influence of currencies on corporate revenues can add up to a double whammy. That is, sales made on the European continent in Euros are negatively impacted when converted into dollars. Further, prices European buyers pay for U.S. goods are higher, making them less competitive and subject to declines from “cheaper” suppliers domiciled on the continent.

Given the evidence of momentum in the U.S. economy and the reports coming out of Europe, and, to a lesser degree, China, currencies represent an issue investors need to keep an eye on. The chart below, which I got from Standard & Poor’s, shows the percentage of revenues of large cap S&P 500 companies generated outside the U.S. in 2013 (the 2014 figures are waiting for all the 10Ks to be filed). As you can see, about half of the revenues are exposed to currency risk.

 

 

Of course, it’s not like investors and chief financial officers take this lying down. They hedge using currency derivatives and their knowledge of the marketplace. And mutual fund managers can hedge too. So, if you try your own kind of hedge, you could undo what CFOs and portfolio managers are already trying to do for you. But this doesn’t mean you can’t take some steps to protect yourself.

First, you could consider using mutual funds where the active management can offer some hedge protection. I would never recommend a wholesale conversion, but some areas of your portfolio might merit a closer look.

Second, if you are an ardent disciple of asset allocation, now might be a good time to consider your share of small cap exposure. According to S&P, small cap stocks have just 15% of their revenues outside of the U.S., versus just over 46% for large cap stocks. But there’s more: Smaller companies that can source overseas, then assemble and sell here are, unlike their large cap brethren, better positioned to capitalize on the current trend in the dollar.

Third, consider the opposite effect of the dollar appreciation on companies in the Eurozone. Their products are getting cheaper for Americans to buy; we expect prices of everything from imported salami to BMWs to decline over the next 6 to 12 months. That means European countries will sell more, which could help the struggling top line of European business. Think about using international diversification as a way to capture the benefits.

Currency often fluctuates, but over the long term, it’s hard to make money by betting on currencies. Currencies self-correct, so if the Euro gets too low against the dollar, the U.S. would buy more goods denominated in Euro, pushing down the dollar and pushing back up the Euro. This cycle will have implications for your portfolio, which is why it’s important to be thinking about the impact currencies can have on the assets you hold.

Jim Cahn is Chief Investment Officer of Wealth Enhancement Advisory Services, the RIA arm of Wealth Enhancement Group. Contact him at jcahn@wealthenhancement.com.

Originally published on forbes.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Other Topics

Earnings