The recent surge in the US dollar presents a significant challenge to the earnings outlook for major US multinational corporations, including tech giants like Amazon and Apple. This raises concerns about the sustainability of the current stock market rally, which has been largely fueled by robust profit growth in recent years.
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The dollar’s approximately 7% climb since its September low, reaching levels not seen since November 2022, poses a threat to Big Tech stocks, particularly those with high valuations. These companies have been key drivers of the S&P 500’s bull market for the past two years. While a recent delay in US tariffs on Canada and Mexico provided some relief, demand for protection against further dollar appreciation remains at a two-year high, largely driven by economic policies.
Currency Headwinds Impacting Corporate Bottom Lines
According to Howard Du, a currency strategist at Bank of America, the unexpected strength of the dollar is a major factor impacting corporate earnings. Goldman Sachs Group Inc. reports that nearly 40% of S&P 500 company earnings calls have mentioned foreign exchange (FX) challenges. Apple anticipates these headwinds to persist, and while Amazon’s latest quarter showed positive results overall, concerns linger due to first-quarter guidance falling short of expectations, partly attributed to currency effects. A strong dollar diminishes export demand and reduces the value of overseas earnings when translated back into US dollars.
Historical Precedent: Dollar Strength and Earnings Recessions
Patrick Fruzzetti, a portfolio manager at Rose Advisors, highlights the potential for dollar strength to negatively impact companies, even in the absence of tariffs. Historical data supports this concern. When the dollar surged by over 25% in mid-2014 and again between 2021 and 2022, S&P 500 companies experienced earnings recessions. A 10% dollar gain combined with tariff shocks in early 2018 further impacted profits, leading to a nearly 20% drop in the S&P 500.
Dollar’s Trajectory and Investor Sentiment
There is a widespread expectation that the dollar will remain strong, potentially extending into 2025, according to Paula Comings, head of FX sales at U.S. Bancorp. While stock investors often overlook the negative earnings impact of a strong dollar when equity valuations are high, the current situation warrants attention. The “Magnificent Seven” stocks – a group of high-performing tech companies – are currently priced at 30 times projected profits, significantly higher than the S&P 500’s 22 times and considerably above their valuation of 20 at the end of 2022. This elevated valuation makes these companies more susceptible to earnings disappointments.
Conclusion: Navigating the Dollar’s Impact
The strong dollar poses a tangible threat to US corporate earnings and the ongoing stock market rally. While investors have historically shown resilience to currency fluctuations, the current confluence of high valuations and persistent dollar strength demands careful consideration. The potential for earnings contractions and market corrections underscores the need for investors to closely monitor currency movements and adjust their investment strategies accordingly. Diversification across geographies and sectors may be crucial to mitigate the risks associated with a sustained strong dollar.
