Over the past year or more, the international portion of the earnings results of US publicly traded companies has suffered from the strength of the US dollar.
-By and large, US products sold in foreign countries are priced in local currency. When the dollar rises, the dollar value of foreign sales falls. Speaking in the most general terms, firms can raise prices without damaging sales volumes only at the rate of local inflation, meaning that it can take quite a while for a US company to recoup a currency-driven loss through price increases.
-The rise in the dollar has come from two sources:
–the collapse of the currencies of emerging countries with unsound government finances and radically dependent on exports of natural resources like oil and base metals, and
–the greater strength of the US economy vs. trading partners like the EU and Japan.
-What appears on the income statement as a currency gain or loss is the result of a complex process with two components: cash flows; and an adjustment of balance sheet asset values. There’s no easy way to figure out what the exact number will be.
-We do know, however, the very important fact that the dollar has been weakening against the euro and the yen for the past several months. If the quarter were to end today, the euro would be 3.2% stronger vs. the dollar than at the end of 1Q15. The yen is now 5% stronger than it was at the end of last March. The Chinese renminbi is 5% weaker against the dollar than this time a year ago, but there’s much greater scope to raise prices in China.
My conclusion: US companies with mainly and EU or Japanese assets/earnings will likely post modest foreign exchange gains during 1Q16 vs. large losses in 1Q15.
Hedging? Many international firms try, more or less successfully, to smooth their foreign earnings by hedging. This activity is crucial for an exporter with long lead times, cosmetic for everyone else. The key point, however, is that in my experience when hedging results in a gain, this is recognized in operating profit and companies say nothing. When the hedging makes a loss, companies disclose the figure and argue that this is a non-recurring item. For whatever reason, Wall Street usually ignores a loss of this type.
So, ex emerging markets, currency can be a significant positive surprise for internationally-oriented firms this quarter, instead of the earnings drag it has been in recent quarters. My guess is that Wall Street hasn’t factored this likelihood into prices yet.