Strong Dollar Woes Are Weaker Than Many Fear

Lately—and predictably—we have seen a fair amount of handwringing about the dollar. It seems like just yesterday people were worried it was too weak. Yet now it is supposedly too strong, threatening US multinationals’ earnings. Some companies have already started blaming it for worse-than-expected results. Now, in our experience, the dollar rivals the weather as possibly companies’ favorite scapegoat when lowering guidance for future earnings, and it wouldn’t surprise us if some were merely reverting to old blame habits. For a strong dollar isn’t inherently good or bad—it just is.

Conventional wisdom says a strong dollar is bad for big exporters because it can hit revenues. When the dollar is strong, if a company wants to charge the same amount in dollars for a given product sold abroad, it has to raise prices in the receiving country’s currency. That can limit demand. Or, to preserve demand, the company can hold prices in the end market’s currency constant, reducing the amount they get in dollars. Sales volumes may hold up better, but revenues fall, and profit margins take a hit.

That is the theory, and mathematically it is true. But it ignores a key mitigating factor: Few companies source all components and manufacture final goods in their home country. The vast majority of firms import parts, raw materials and even labor. A strong dollar makes all of these imported costs cheaper. It may not be a perfect offset for the hit revenues can take under these conditions, but it does cancel a good deal of the effect and help preserve margins. It may even benefit some firms more than the strong dollar hurts sales. But also, beyond this, most companies also hedge for currency swings, limiting the impact of sharp moves. Note that with most companies reporting, S&P 500 gross operating profit margins (revenue minus cost of goods sold, divided by revenue) held pretty darned firm in Q1, slipping less than a quarter of a percentage point from Q2.^[i]

The numbers bear this out. The last time the dollar was this strong with no associated recession ongoing was in 2018 and 2019. That first year, S&P 500 earnings grew 10.2% y/y, 18.2%, 23.7% and 20.3% in Q1, Q2, Q3 and Q4, respectively.^[ii] Growth stayed robust in Q1 2019 at 17.3%. It weakened into the low single digits over the rest of the year, but we think that has more to do with base effects—elevated comparisons from 2018. Said differently, earnings grew slowly off a high plateau in 2019’s last three quarters, even as the dollar stayed elevated. Stocks had a great year, too. Earnings looked worse when the dollar was strong in 2016, but that stemmed from rock-bottom oil prices wrecking Energy sector earnings. Outside Energy, earnings grew nicely, and total S&P 500 earnings bounced nicely in 2017. Then, too, stocks did quite well both years.

In our view, dollar fears are telling mostly about sentiment. Whenever investors have the blues, they will inevitably turn to the dollar. If it is weak, we get fears of a weak dollar jacking up import costs, hurting earnings and driving inflation. If it is strong, we get fears like the present. In reality, currency is but one variable affecting profits—and one companies are extremely adept at weathering and planning for. That is a big reason there is no meaningful relationship between the dollar and stocks, and we doubt this time proves different.