We've talked in recent weeks about the way markets are set up nicely for positive surprises. Earnings had been downgraded dramatically. Now we've had 87% of the companies in the S&P 500 report for the first quarter, and 71% have come in with better than expected earnings. And more than half of the companies have beat revenue estimates.
As we've said, this is how Wall Street works. Expectations are priced into markets. Surprises reprice markets. And Wall Street sets the expectations. That means earnings tend to be a built-in bullish catalyst for stocks, adding to the bullish bias for the broad stock market. And as we've discussed, also setting the table for positive surprises: economic data. The sentiment has been overly gloomy. With that, growth and inflation estimates have been dramatically downgraded. That sets up for positive surprises. For people looking for reasons to be optimistic. That's a reason.
While we're on the topic of earnings. Today we want to talk about the dollar.
Many have claimed the strong dollar to be a significant headwind for stocks. Even though most companies have beat estimates, many have also complained the strong dollar has hurt exports - again, managing down expectations.
The reality is, when the dollar is weak, companies complain. When the dollar is strong, companies complain.
Take a look at these headlines from mid 2009.
“Alliance Data 2Q Profit Down 37 Percent, Hurt By Currency Headwinds”
“McDonald’s Profit Narrows By 8 Percent On Currency Exchange Impact”
“Pepsi 2Q Down 2 Percent On Currency, North American Pressures”
“Omnicom Profit Plummets As Economy, Currency Do Damage”
At this time, the dollar was at the tail end of an aggressive seven year downtrend. And for the quarter referenced in these 2009 earnings headlines, the dollar index, measured against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc, lost 6 percent during that period. The dollar was weak.
So why would companies blame losses on currencies even as the dollar weakened? Because most large multi-national companies have active currency strategies (i.e. they have hedging strategies, which often turn into speculation on currencies) -- and they don’t all win. In fact, they are not very good currency traders.
Take McDonald’s for example. In the first quarter of 2009, McDonald’s (MCD) reported losses from currencies. The dollar was 5 percent stronger during that period. In the second quarter, MCD reported losses from currencies while the dollar was weaker by 6 percent! The impact should have been positive. The company gave away 9 percent of its earnings each quarter because of the "negative drag from foreign currencies."
What's the takeaway? If you're evaluating the outlook for U.S. stocks and you think a strong dollar is a problem, you should consider that stocks have had a long term upward slope through six cycles of dollar strength and weakness, following the failure of the Bretton Woods system. In fact, the S&P 500 has gone from under 100 to over 2,000 during the period. And the average change in the dollar (as measured by the dollar index) within those up and down cycles has been 56% -- not small.
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