King Kong wreaks havoc. “King Dollar” doesn’t. Photo by Hulton Archive/Getty Images.
Well that didn’t take long. Just three weeks ago, headlines were all “Rah Rah Strong Dollar U-S-A! U-S-A!” Now they’re like this: Surging dollar may be triple whammy for US earnings. King dollar question mark for earnings and stocks. The strong dollar’s risk to 4Q earnings and beyond. Surging dollar may destroy US company earnings. Latest threat to corporate earnings: the almighty dollar. Their logic: A stronger dollar makes exports more expensive, making overseas business less profitable for globalized firms.[i] However, historically, there isn’t much (if any) evidence backing this case: A strong dollar isn’t inherently bad for US earnings, trade or stocks.
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First, the theoretical evidence. Yes, a strong dollar, all else equal, makes exports pricier, and a weak dollar makes them cheaper. But the reverse is true for imports—strong dollar means cheaper imports, weak dollar means pricier imports. For most firms, these little factoids help cancel out most of the impact of a currency swing. Few US exporters make goods start to finish with American components. Even Coca-Cola—as American as apple pie—imports ingredients. When the dollar gets stronger, imported ingredients (or, for other firms, parts and resources) get cheaper. Production gets cheaper as a result, offsetting much of the drag from pricier exports. When the dollar gets weaker, imported components and production become more expensive, offsetting the benefits of having cheaper exports. This is why the weak yen hasn’t fixed Japan.
Second, the numbers. There is no link between the dollar and earnings growth. Exhibit 1 shows the y/y change in S&P 500 earnings per share and the US dollar broad trade-weighted index since 1997. As you will see, there is a lot of noise. Sometimes they move together, sometimes they don’t.[ii] Those spikes in 2008 are coincidental, by the way—in a deep recession, earnings usually tank, and investors globally usually flock to perceived safety, i.e, Treasurys and the dollar. That happened starting in late 2008.
Exhibit 1: S&P 500 EPS Vs. US Dollar
Source: FactSet, as of 10/06/2014. Y/Y percentage change in S&P 500 earnings per share and the US Dollar Broad Trade-Weighted Index. 12/31/1996 – 9/26/2014.
This is a big reason why the dollar and US stocks don’t have a set relationship, as Exhibit 2 shows.
Exhibit 2: Yearly Change in the S&P 500 Price Index and US Dollar
Source: FactSet, as of 10/06/2014. Annual change in the S&P 500 Price Index and US Dollar Broad Trade-Weighted Index, 1974 – 2013.
The same is true for the dollar and trade. While it can be a fringe factor, a weak dollar is not such a huge factor that it makes imports sink and exports rise. Nor does a strong dollar make imports jump and exports tank. As Exhibits 3 and 4 show, they’re all just randomly squiggly wiggly—except for those spikes in 2008, which, again, are a function of the recession.
Exhibit 3: US Exports Vs. US Dollar
Source: FactSet, as of 10/06/2014. Y/Y percentage change in monthly US exports and the US Dollar Broad Trade-Weighted Index, 12/31/1993 – 8/31/2014.
Exhibit 4: US Imports Vs. US Dollar
Source: FactSet, as of 10/06/2014. Y/Y percentage change in monthly US imports and the US Dollar Broad Trade-Weighted Index, 12/31/1993 – 8/31/2014.
As you probably noticed on those two charts, imports and exports tend to move pretty similarly—up in good times, down in bad. If currency were really a driver, one would expect imports and exports to move in opposite directions as the dollar was a headwind on one and a tailwind for the other. This clearly isn’t the case! Trade has much, much more to do with the economic cycle. Currencies are fungible, but the stuff you buy with them isn’t necessarily so interchangeable.
This is especially clear when you look at US trade with individual countries. Exhibits 5 – 8 show trade with the UK, Germany, Japan and Canada, along with each bilateral exchange rate since Q1 1999, the earliest available country-specific trade data. The dollar largely weakened against each during the 2002 - 2007 expansion, but in all four cases, imports and exports rose. And at fairly similar paces, overall and average. There is some divergence in Japanese and German exports and imports during this cycle, but that seems more a function of economic trends in those countries (eurozone crisis for Germany, Japan being Japan).
Exhibit 5: US Trade With the UK
Source: FactSet and US Bureau of Economic Analysis, as of 10/06/2014. Total exports and imports of goods and services between the US and UK, quarterly, and the GBP/USD exchange rate on the last day of each quarter, Q1 1999 – Q2 2014.
Exhibit 6: US Trade With Germany
Source: FactSet and US Bureau of Economic Analysis, as of 10/06/2014. Total exports and imports of goods and services between the US and Germany, quarterly, and the EUR/USD exchange rate on the last day of each quarter, Q1 1999 – Q2 2014.
Exhibit 7: US Trade With Japan
Source: FactSet and US Bureau of Economic Analysis, as of 10/06/2014. Total exports and imports of goods and services between the US and Japan, quarterly, and the JPY/USD exchange rate on the last day of each quarter, Q1 1999 – Q2 2014.
Exhibit 8: US Trade With Canada
Source: FactSet and US Bureau of Economic Analysis, as of 10/06/2014. Total exports and imports of goods and services between the US and Canada, quarterly, and the CAD/USD exchange rate on the last day of each quarter, Q1 1999 – Q2 2014.
We could make similar charts for other major trading partners, but they wouldn’t look much different—trade up and down with the cycle, regardless of the dollar’s own ups and downs.
Even with the strong-dollar-bad myth gutted, however, we wouldn’t be surprised if companies that happen to post weaker earnings for Q3 or Q4 blame the dollar—it’s an easy scapegoat. People will buy it, and that can help take the heat off execs if results are disappointing. But don’t confuse their PR spin with proof of cause and effect.
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[i] The dollar is one of those things skeptics try to have both ways. When it’s weak, everyone forgets the “weak currencies boost exports” myth and fears the weakening currency means the US is less competitive, less desirable, losing dominance, going down the tubes and all the rest. Irony can be pretty ironic sometimes.
[ii] There is another point to explore here, which is the fact that a good chunk of US corporations’ foreign earnings are never repatriated (largely due to tax reasons) and therefore not converted to dollars. They’re just reinvested abroad. This, too, mitigates the impact—and helps further globalize operations, further watering down the currency effect.