Dollar Upside Threatens Earnings Numbers

Just a few months ago, the doomsday crowd was crowing about the weakening dollar, which was portrayed as a grave threat to the U.S. economy while being blamed for stubbornly high oil prices and rising import costs. Now that the greenback has defied conventional wisdom and rallied sharply, there's something new for investors to worry about: the bite a stronger dollar will take from S&P 500 profits.

Defying Wall Street's consensus forecasts for the dollar to decline by 10% this year, the buck has so far rallied about 3% against major currencies. Intraday Monday, the dollar hit highs for the year against the euro, sterling, Swiss franc and yen before giving back some of the gains. The euro was at $1.2109 late Monday, a nine-month low, after touching $1.2060 intraday and threatening to break below the key $1.20 level.

"We are amazed that no one else on the Street has begun to at least tinker with their EPS estimates since very, very few were carrying $1.22 on dollar-euro or 108 dollar-yen in their top-line numbers at the start of the year," says David Rosenberg, chief North American economist at Merrill Lynch. Should the dollar fail to weaken significantly again, current earnings expectations would have to come down.

If the dollar merely maintains its year-to-date gains, the consensus operating EPS for 2005 for the S&P 500 would fall to $72.80 from $74.50, according to Rosenberg. In terms of comparisons, year-on-year growth would fall to 7.6% from 10%. That's because more than 30% of S&P 500 companies' revenue comes from their overseas operations.

"More to the point -- if the dollar doesn't begin to falter again, we are at risk of a downward adjustment to earnings, and what our research shows is that investors may be lulled into a false sense of security thinking this market is attractive with an estimated 2006 P/E of 14.6 times when in fact the dollar's move actually means that investors are likely paying for a more neutral multiple of 16 times," the economist commented.

Indeed, given Wall Street's optimistic feel since late April, there's little evidence of widespread concern about the dollar's impact on earnings. "Some companies will get affected, but in general it should not be a problem," says Peter Cardillo, chief market strategist at SW Bach & Co.

Ahead of key economic data later this week, the major averages posted modest gains on Monday. The Dow Jones Industrial Average ended up 9.93 points, or 0.1%, at 10,522.56, after rising to an intraday high of 10,589. The S&P 500 added 2.71 points, or 0.2%, to 1200.82, off a high of 1206. The Nasdaq Composite advanced 5.96 points, or 0.3%, to 2068.56, off a high of 2078.