The dollar did it.
More than any other factor in the second quarter, currency translations swayed financial results of many high-profile companies, something likely to continue. Subject to debate is whether U.S. multinationals can hope for continued gains in future quarters given the dollar's recent rebound from second-quarter weakness, and how much significance investors should impart to earnings that may have been goosed by favorable currency trends.
Following weakness late last year and in the first quarter, the dollar fell more than 5% against the euro in the second quarter. That made products sold overseas by U.S. multinationals more price competitive compared with their European counterparts, providing a boost to many firms. (The dollar was weak vs. other major currencies as well, but its slide was most pronounced vs. the euro.)
"You're clearly hearing the term 'currency impact' a bunch" this quarter, said Tobias Levkovich, senior institutional U.S. equity strategist at Citigroup Smith Barney.
The currency dividend has been particularly acute at large industrials such as
, but also consumer staples such as
Other firms citing the positive effect of the dollar's weakness on their second-quarter results include
Levkovich, whose optimism earlier this year was based partly on an expectation of a weaker dollar boosting
profits, noted the earnings impact from currencies comes in two flavors. The first is the pure translation, which occurs relatively quickly as currencies fluctuate. The second is how it helps companies' competitive position, which takes longer to manifest and must be sustained in order to influence consumers' habits, he said.
Because of this less ephemeral secondary effect, Levkovich isn't too concerned about the dollar's recent 6% rally against the euro, which settled Thursday around $1.12 vs. its all-time high over $1.19 in late May.
"The dollar could strengthen or weaken
but all things being equal, it could continue to be a positive driver for earnings though the first quarter of next year."
Even with the euro at around $1.12, the second-half comparisons will be favorable vs. the average euro levels of 96 cents to $1.05 in the second-half of 2002, he noted.
Ashraf Laidi, chief currency analyst at MG Financial Group, says the dollar's recent strength against the euro is likely to be capped at just over $1.10, meaning there still will be favorable year-over-year comparison for U.S. multinationals.
Laidi cited the
stated reluctance to raise rates as an impediment to substantially more dollar strength, as the low fed funds rate undermines the relative attractiveness of the dollar's yield vs. other currencies. Conversely, the dollar is unlikely to weaken dramatically because of the stronger growth prospects for the U.S. economy vs. that of the eurozone, he said.
If that outlook proves accurate, this issue of currency translations and how much significance investors should attribute to them is likely to be with us for the next two quarters as well.
Colored by Money
To optimists such as Levkovich, it's "disingenuous to hear people say we can't count" the positive effects of currency translations. He correctly noted that a strong dollar in the 1990s hampered the earnings of multinationals, but few observers said those results were "understated." (Of course, those were the glory years when few market participants worried about much, and companies were seemingly producing stellar earnings growth, albeit much of it turned out to be generated by shady, sometimes fraudulent, accounting.)
Chuck Hill, director of research at Thomson First Call, agreed currency gains (or losses) should be included in earnings results. However, there is value in excluding currency translations in terms of analyzing the underlying trends in a company's or sector's growth, he said.
In the first quarter, for example, tech-sector earnings were up 17% but revenues only grew by 2%. "In effect, you had no change in revenues" and superficially strong earnings growth was mainly the result of cost-cutting and currency gains, he said. Analysts are expecting similar second-quarter results, forecasting earnings appreciation of 20% for the tech sector but only 3% revenue growth. "It's the same situation
and it's not encouraging," Hill said.
On a micro level, this issue manifested itself Thursday when shares of IBM fell 3.9% despite apparently solid second-quarter results. If not for positive currency translations, however, IBM's earnings would have been a penny shy of expectations and sales from continuing operations up just 3%, rather than by 10% to $21.6 billion, as reported by the company. (Excluding currency translation and the effects of acquisitions, IBM's revenues would have declined by 2.5%.)
Concerns about IBM's core business growth -- a cautious comments about IT spending -- contributed to
Thursday's steep slide by tech proxies. Also weighing on indices were results from
In contrast to their American-based counterparts, these European-domiciled firms had their results hampered by the dollar's second-quarter weakness and corresponding euro strength.
Indeed, some companies are aided by a weak dollar and others are hurt by it. Furthermore, it's pretty much impossible to know which companies are hedging their currency exposure (and to what degree), observed Liz Ann Sonders, chief investment strategist at Charles Schwab. For those reasons, she cautioned about reading too much into currency issues.
"It's not appropriate to make broad investment decisions purely by virtue of the dollar's fluctuations" and impact on corporate earnings, Sonders said.
The strategist did, however, say the manner in which market participants accept or refute currency-influenced earnings says something about the state of market psychology. Furthermore, such earnings minutiae will play a prominent role in short-term trading.
Given the increasingly short-term focus of many market participants and the dollar's likely path, that suggests this issue of currency translations will be a contentious one for some time.
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
Aaron L. Task.