Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

Dollar strength posing a threat to company profits

Companies eye currency crunch surprises
Companies eye currency crunch surprises

As the thick of earnings season begins this week, be prepared to hear that the strong U.S. dollar is the culprit behind many disappointments.

This will be a tough year for earnings partly due to continued dollar strength, said Steve Wood, chief market strategist at Russell Investments. The dollar index, which measures the greenback against a basket of global currencies, is up more than 7 percent over the past year.

In 2015, the dollar enjoyed its fastest rise in 40 years, and it continues to gain steam against the world's other major currencies. The greenback has skyrocketed 20 percent since mid-2014 and it's now nearing parity with the euro.

Data provider S&P Capital IQ says fourth-quarter earnings from S&P 500 companies are expected to shrink by nearly 6.5 percent, potentially marking the first back-to-back decline since 2009. Some 39 companies in the S&P 500 are reporting earnings this week. Just 31 companies had reported through Friday, with 69 percent beating expectations.

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Dollar strength might seem like a reflection of U.S. economic power, and it may even be good news for the pockets of American consumers. But its impact on corporate earnings and the market isn't all that great.

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A strong currency makes U.S. exports and products more expensive for other countries. It also means that the value of overseas sales is reduced when converted back into dollars.

The rising dollar negatively influences companies that have a huge global presence as they end up trading in a weakened domestic currency. Almost half of all revenue for companies in the comes from outside the U.S., mainly Europe and Asia.

For the first quarter of 2015, Ford said 70 percent of its global revenue decline was due to the effects of currency-exchange fluctuations. Yum Brands, in reporting third-quarter earnings, stated "foreign currency translation remains a strong headwind" and that it expected the exchange rate "to impact full-year earnings per share by about 5 percentage points." For Q3, PVH said its bottom line was certainly getting hurt because of the weak dollar. Monsanto reported a loss for the fourth quarter, citing the strong dollar.

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That's just a handful of companies expected to continue to demonstrate the onslaught of the strong dollar. Plus, America's economy certainly won't stop the greenback's surge.

The job market is on a tear, growth is picking up, the Fed may continue to raise rates, and other countries and regions such as China and Europe are going through their own changes and weakness.

The direction of the dollar is pivotal this year. A further dramatic rise could spell trouble.