Dollar strength reminds Wall Street that ‘American exceptionalism’ is not isolationism: McGeever By Reuters

Author: Jamie McGeever

ORLANDO, Fla. (Reuters) – While “American exceptionalism” has undoubtedly helped fuel Wall Street’s record returns in recent years, it should not be confused with isolationism.

The U.S. fourth-quarter earnings season, which begins in earnest this week, is a reminder that U.S. companies—as magnificent as some may be—still operate in a global marketplace. Weak economies and weak demand abroad, combined with a strong dollar, could erode the profitability of American businesses, calling into question whether the US is so exceptional after all.

With the large and rapid appreciation of the dollar, exchange rates will soon bite into corporate profitability. The question is how deep.

Analysts at Apollo Global Management (NYSE: ) note that more than 41% of the company’s revenue comes from overseas. That’s the most since 2013 and not far behind 2011’s record high of 43.3%.

This makes these companies vulnerable on two levels. First, weaker growth in many key economies and trading partners such as China, Canada and Europe should, all else being equal, cause demand for US goods to weaken. And secondly, income collected abroad will now be worth significantly less in dollars than it would have been a year ago.

The dollar is on the tear. It grew 10% since the end of September and 7% compared to the previous year. It is now the strongest in more than two years against a basket of G10 currencies, hitting multi-year highs against sterling and the Canadian dollar.

There is little sign that this trend will reverse anytime soon, as resilient US growth and flat inflation push up government bond yields and prompt investors to radically revise their Fed outlook for 2025. Bank of America economists no longer expect any rate cuts this year, and others are even suggesting that the central bank’s next move could be to hike. On the other hand, Goldman Sachs analysts on Friday raised their forecasts for a “longer-term stronger” dollar.

THE IDIOSYNCRASY OF THE DOLLAR

While much of the classic economic game has been disrupted by the pandemic, theory still suggests that a 10% year-over-year increase in the dollar should reduce S&P 500 earnings by about 3%, according to BofA. Currently, estimates point to 9.5% growth in total earnings per share for the fourth quarter, and 14% for the calendar year 2025, according to LSEG I/B/E/S.

But revenue growth in the fourth quarter is estimated at just 4.1%, which is relatively slow, partly due to the exchange rate.

Revenues tend to fall during periods of a strong dollar compared to periods of a weak dollar, Goldman Sachs analysts said. Therefore, we can reasonably expect the share of companies that exceeded consensus sales forecasts this quarter to be lower than the 42% in the previous period, when year-over-year growth in the dollar was only 2%.

But while dollar strength is likely to feature in many CEO and CFO calls this earnings season, its impact on U.S. earnings may be more “idiosyncratic” than widespread, according to Morgan Stanley (NYSE:) Mike Wilson.

He noted that stocks of companies with “relatively low exposure to foreign sales and low sensitivity to a stronger dollar from an EPS growth standpoint” have started to outperform since the dollar started to strengthen in October.

He characterizes “low” foreign exposure as companies that derive less than 15% of their revenues from abroad, giving them “minimal” sensitivity to the dollar exchange rate. Some of the big names in this camp include United Healthcare, T-Mobile and Home Depot (NYSE: ), while some large caps that derive more than 15% of their revenue from overseas include PepsiCo (NASDAQ: ), IBM (NYSE: ) and Oracle (NYSE: ).

The strength of the dollar is not yet at a level that truly threatens the competitiveness and profitability of corporate America. But if it lasts, this earnings season could be a taste of what’s to come.

(The opinions expressed here are those of the author, a Reuters columnist.)

(Author: Jamie McGeever; Editing: Andrea Ricci)