Trader Talk

Two big problems hurting multinationals in Q2

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It's happening again. In Q1, the two most relevant drags on revenue and profits for multinational companies who got a big chunk of their profits and revenues overseas were: 1) slow global growth, particularly China, and 2) the strong dollar.

Both are resurfacing as issues in Q2.

The dollar finally began to weaken in April, and many were hopeful that multinationals would finally get a break. But after bottoming in mid-May, the dollar has begun strengthening again.

Take United Technologies, which lowered 2015 guidance due to softness in Aerospace, softness in Europe (particularly hurting Otis Elevator) and softness in China. That enough softness for you?

But they also went out of the way to note how the strong dollar was impacting them. Like many multinationals, they are again breaking out earnings and revenues in two form: excluding the impact of foreign exchange, and then including the impact.

Take Otis Elevator. Look at this:

Otis Elevator
(2015 operating profit, YOY)
Excluding forex impact: down $25-$-$75 million
Including forex impact: down $300-$350 million

That is a lot of coin for the impact of the dollar!

How serious an issue is the strong dollar?

UTX said earnings would have been 6 cents higher than the $1.73 reported if the effects of the stronger dollar was excluded. That's not trivial.

How serious is this for other multinationals? It's hard to break out the effect, since not every company breaks out currency. But you can get a hint if you divide the S&P 500 into two groups: those that get at least half their sales outside the U.S. (meaning they are very exposed to the stronger dollar) and those that get less than half outside the U.S.

For companies that get MORE than half their sales outside the U.S., Q2 blended earnings are estimated to be UP 10.5 percent, according to Factset.

For companies that get LESS than half their sales outside the U.S., Q2 blended earnings are estimated to be UP 1.7 percent.

That is quite a difference!

This is what the combination of slower growth and a strong dollar will do for earnings!

The strong dollar is another reason currency-hedged ETFs have seen increasing volume in the past month, particularly the two largest players, the WisdomTree Europe Hedged ETF, and the WisdomTree Japan Hedged ETF.

These ETFs are a way for the average investor to protect against currency fluctuations, and there are more coming. Tomorrow, IndexIQ is launching a whole family of 50 percent currency-hedged ETFs that's a further refinement of the same idea.