Two recurrent words in fourth-quarter earnings releases have been “currency translation.” Currency translation is the conversion of revenues, expenses and earnings realized in a foreign currency into U.S. dollars for reporting purposes. Depending on exchange rates, currency translations can be either a positive or a negative.
What I haven’t seen discussed in the earnings reports I’ve read so far is the impact on competiveness. To the extent that a stronger dollar makes American products more expensive, products from domestic/continental companies become more attractive from a price standpoint in their respective countries or currency zones. Several U.S. companies are pointing to the weak economic environment in Europe as a headwind, but not a loss of market share. It may too early for the stronger dollar to have an impact on competitiveness and/or it may be difficult to separate the headwinds caused by the European Union’s sluggish economy from the loss of market share caused by the stronger dollar.
The types of companies to have reported so far also has an impact. Earnings season typically starts with the largest companies reporting first, followed by smaller companies and then the retailers operating on a February-January fiscal year instead of a January-December fiscal year. To the extent that the large- and mega-cap companies conduct a larger proportion of their business in Europe and other international localities than mid-cap or small-cap companies, their revenues and earnings will be impacted more by currency fluctuations. Business models differ, so this statement does not universally apply to every large or small company.
The impact of currency translations can be somewhat (but not completely) avoided by investing solely in U.S. companies with domestic, but not foreign, operations. By doing so, you increase your exposure to the health or weakness of the domestic economy. You also limit the number of investment candidates to choose from and potentially leave yourself with a portfolio that is less diversified than it would otherwise be.
You could, of course, take positions in the currency market as a hedge. There does exist a diversification argument for holding currency funds or international bond funds. What I would caution against is directly trading in the foreign exchange (“forex”) markets. There are sophisticated firms with professional traders and staffs of economists competing against you in a market that is open 24 hours a day. While technical analysis can be used to spot trends, the professional traders see the same chart patterns. In my opinion, the odds in the forex markets are simply stacked too high against you and me.
A stronger dollar will always be a paradox for U.S. investors. As the dollar strengthens, it hurts corporate profits. It also reduces the value of our foreign investments in dollar-denominated terms. On the other hand, it feels good from a patriotic standpoint. A stronger dollar makes foreign-made products cheaper for us to buy. It also allows us to buy more shares of foreign companies and foreign funds for the same amount of dollars spent. Plus, should the euro rebound from current levels, you would get the benefit of a more favorable currency conversion plus any appreciation in the value of the investments beyond what is directly related to currency fluctuations.
The Week Ahead
More than 60 members of the S&P 500 will report earnings next week. Included in this group are Dow Jones industrial average components The Coca-Cola Co. (KO) on Tuesday and Cisco Systems (CSCO) on Wednesday.
The week’s first economic report of note will be the December Job Openings and Labor Turnover (JOLTS) Survey, released on Tuesday. Thursday will feature January retail sales and December business inventories. The preliminary February University of Michigan consumer sentiment survey and January import and export prices will be released on Friday.
The Treasury Department will auction $24 billion of three-year notes on Tuesday, $24 billion of 10-year notes on Wednesday, and $16 billion of 30-year bonds on Thursday.
Two Federal Reserve officials are scheduled to make public appearances. Richmond president Jeffrey Lacker will speak on Tuesday and Dallas president Richard Fisher will speak on Wednesday.About The Author - Charles Rotblut, CFA is the VP and Editor for American Association of Individual Investors (AAII). Charles is also the author of Better Good than Lucky. (EconMatters author archive here)
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.
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