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The US Corporate Earnings Recession From The Strong Dollar; Don't Worry Too Much

This article is more than 9 years old.

It's entirely true that the US dollar has risen strongly against other currencies in recent months. This should, and will, have an effect on US corporate earnings, those of multinationals. However, it's easy to become too worried about this: the general effect of all of the movements should be positive for US corporate earnings, even while those of some companies might suffer. This is because macroeconomics is about, well, the "macro" view of the economy, where we tot up all of the different effects to try and see what the total one is. When we add together why the US dollar is rising and also the effects of it rising that total effect just isn't going to be as bad as some might think.

Here's an interesting little warning of what the strong dollar will do:

Strategists at Bank of America /Merrill Lynch term the condition created by the moves of greenbacks with such a magnitude in the past few months as an “earnings recession”.

In general terms, ‘earnings recession’ is defined as at least two successive quarters of drop in the earnings from the quarters of years earlier.

According to the brokerage, a 25 percent surge in the greenbacks in a 12-month period has historically coincided with a drop of 10 percent in the earnings of market per share.

Well, OK, let's just politely assume that the first language of that reporter is not in fact English. But yes, the point that is being made is obviously true. Certain American companies (we usually call them multinationals) have large businesses outside the US. These make profits but they make those profits in the currencies used outside the US. So, a company operating in the UK (Walmart owns Asda for example) will be making those profits in pounds sterling. Apple makes good profits in euros and more recently in the Chinese yuan. Many other companies ( Microsoft comes to mind here) make profits in just about every currency under the Sun. So, the US dollar rises against those other currencies. Those profits, which accrue to the shareholders of Walmart, Apple and Microsoft, are translated in the companies' books back into US dollars. Thus the profits in those other currencies might be the same but they look smaller in US dollars.

That's the point that they are getting across. But macroeconomics doesn't work in just that manner. Because we are trying to look at the whole economy. It's also going to be true that the people who import stuff into the US economy are going to be making larger profits. There's even a whole theory (called the J-Curve) about how this happens. Sure, the dollar goes higher, imports are cheaper, but that first flush of imports being cheaper goes to boost the profit lines of the importers rather than lower costs for consumers. It's only later, as competition strikes, that consumer prices decline and thus profit margins go back to normal.

So, some portion of corporate profits will fall, some will rise. It depends upon the balance of exports to imports, of overseas earnings to domestic. And given that the US runs a trade deficit the likely (no, not the certain, just the likely) impact on corporate profits overall will be positive. Sure, you'd like to be properly positioned but here I'm about macroeconomics, not investment advice.

However, there's one more thing to think about here. Why is the US dollar rising against other currencies? Because the economic prospects for the US look better than they do for other countries. And better economic prospects usually mean an increase in corporate profits (profits are usually much more variable over the business cycle than any other portion of the economy). So our underlying intuition is that if the dollar is rising then we must be thinking that US corporations are going to be making better profits.

Yes, agreed, the dollar value of those foreign profits is going to be falling: but the general level of profit in the US economy should be rising at the same time.

The decline of the dollar value of overseas earnings is an obvious and true result of the dollar rising in value. That doesn't in fact lead to a true conclusion that there's going to be a fall in corporate earnings as a result of the rise in the dollar. Simply because there's more than one effect at work in that macroeconomy. Yes, it's difficult, but then if this was all easy we'd all be Warren Buffett, right? And as this delightful story shows, it's a little more difficult than that.

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