Weak global growth, strong U.S. currency raise potential for disappointing earnings
By Amrith Ramkumar
Investors worried about the impact of the coronavirus on the world economy might soon have to confront another challenge to corporate profits: a strengthening dollar.
The U.S. currency has climbed steadily since the number of coronavirus cases began surging in China last month, pushing the WSJ Dollar Index to its highest level since early October. With many analysts concerned that disruptions to the Chinese economy will dent global growth, investors have been clinging to U.S. assets, helping the S&P 500 rebound from its late-January slide and rise last week to a fresh record.
Although major indexes and the dollar have climbed in tandem, U.S. companies including Johnson & Johnson, Coca-Cola Co., Ford Motor Co. and 3M Co. have mentioned the negative effects of currency swings on earnings calls, highlighting a possible challenge to the longstanding bull market. A stronger dollar makes it more expensive for companies to bring home foreign sales and makes exporters' products less competitive abroad.
Fourth-quarter profits for S&P 500 firms are on track to stay roughly flat compared with a year earlier, extending a trend from earlier in 2019. The combination of weak global growth and a strong dollar raises the possibility that earnings could disappoint again this year. Any negative impact from the dollar could amplify the fallout from the coronavirus, which has already forced chains from Starbucks Corp. to Nike Inc. to close stores in China temporarily.
Some firms, including McDonald's Corp. and Yum China Holdings Inc., which operates Pizza Hut and KFC in the country, have already discussed the uncertain impact of the virus.
"No one knows how this outbreak will play out, and we don't know how it will ultimately impact us," Royal Caribbean Cruises Ltd. Chief Executive Richard Fain said on the company's earnings call last week. The company has already canceled some cruises out of China.
Analysts expect S&P 500 profit growth to accelerate to 10% or higher in the last two quarters of 2020, according to FactSet, a projection that some investors fear will now be hard to hit. Investors will be monitoring results this week from a group highlighted by PepsiCo Inc., Cisco Systems Inc. and Nvidia Corp.
A rising dollar also affects emerging markets and commodities by making investments denominated in the U.S. currency more expensive for overseas buyers. Additionally, it becomes more costly for developing countries to service dollar-denominated debt when the currency climbs.
Investors have for years expected global economic growth to weaken the dollar, only for the currency to defy those predictions. President Trump has consistently criticized the dollar's strength in recent years, arguing that it places the U.S. at a competitive disadvantage. He has also cited the dollar in his criticism of the Federal Reserve, urging the central bank to lower interest rates further.
The currency's recent advance comes even after three Fed rate cuts in the last half of 2019, the latest example of sturdy U.S. growth attracting investors but potentially adding to a murky earnings backdrop for large companies.
"Expectations might not be met, and that's a market risk," said Lauren Goodwin, an economist and multiasset portfolio strategist at New York Life Investments, which holds a smaller position in U.S. stocks than the benchmark it tracks. "Markets can only defy fundamentals for so long."
Multinational companies have already been under pressure, with earnings from S&P 500 firms that get more than half of their revenue outside the U.S. coming in worse than profits for more domestically oriented companies for much of last year. Many of those firms are now contending with the prospect of weaker Chinese demand and a stronger dollar.
"They're facing a double whammy," said Mona Mahajan, U.S. investment strategist at Allianz Global Investors, which has been favoring U.S. stocks and the dollar recently.
The dollar and investments tied to U.S. growth also outpaced other assets for much of 2019, with analysts worried about trade tensions. As the new year started, many investors had expected the trend to reverse following an initial trade deal and clarity on the U.K.'s exit from the European Union.
Instead, traders are now questioning whether the world economy can reaccelerate.
"That story is now on hold," said Emily Roland, co-chief investment strategist at John Hancock Investment Management. "We're maintaining our preference for the U.S. because it's the best from an economic growth standpoint."
Still, some analysts don't see the dollar climbing out of its recent trading range, particularly with the Fed indicating it plans to leave rates low for now. Many are skeptical that an unforeseen event such as the coronavirus that boosts the currency temporarily can provide longer-term support without also threatening economic growth in the U.S.
But for now, investors have kept buying U.S. assets. The yield on the benchmark 10-year U.S. Treasury note, which affects borrowing costs on everything from student debt to auto loans, fell last week to its lowest level since early October. Yields fall as bond prices rise.
Traders have also cited a reversal in investor positioning in explaining the market's recent swings. Net investor bets on a stronger U.S. currency rose in three consecutive weeks through Feb. 4, after last month hitting their lowest level since 2018, according to the Commodity Futures Trading Commission and Scotiabank. The reversal is another example of many betting against the dollar, only for it to attract investors during turbulent times.
That bearish positioning "getting beaten out of the market has been a very consistent theme," said Ed Al-Hussainy, senior interest-rate and currency analyst at Columbia Threadneedle Investments. "The safe-haven narrative is absolutely critical."
Write to Amrith Ramkumar at email@example.com