With the Euro hovering near its record highs and the British pound having breached the psychologically important 2.000 level, the extent of the US dollars weakness has finally been recognized. As we have seen in the past few months, the value of the US dollar is important not only for currency traders, but also for equity traders. It is hardly a coincidence that the US stock market hit an all time high around the same time that the US dollar reached multi decade lows against currencies like the British pound, New Zealand dollar and the Euro. The strength of those currencies has made US stocks attractive values for foreign investors and looking ahead, the value of the US dollar can be a useful tool for equity traders, especially those who are looking to buy or sell the shares of big US importers and exporters.
US Dollar and the Impact of Its Value on Stocks
In order to assess the impact of the US dollar on stocks, we compare the performance of the Dollar Index with the stocks of Wal-Mart (a big importer) and Boeing (a big exporter). The chart below clearly indicates that a drop in the US dollar leads to the underperformance of Wal-Mart over Boeing. In fact, the correlation between the two components has been a whopping 74 percent over the past few months with the Dollar Index (blue line) often leading the movement of the Wal-Mart / Boeing ratio (red line). The rationale for the correlation is simple. When the US dollar weakens, importers have less purchasing power so they are faced with one of two options, which is either to increase prices or take a hit to profits. Exporters on their hand find their goods automatically more competitively priced in the global market place, which only adds to earnings. Equity traders may find it useful to keep this information in mind when picking which companies to buy or sell.
A Deeper Look Into Who Wins
When we compare Boeing to Airbus - the US and French based companies competing to sell two of the biggest passenger planes in the world, the importance of the value of dollar can be understood further. Sales of Boeings Dreamliner have far outpaced those of Airbuss A380, which has been plagued by delays and production problems. Furthermore, Boeings profitability prospects are far greater than that of Airbus, as the Dreamliner is priced in US dollars whereas Airbuss products are priced in Euros. Given this pricing advantage, Airbus has gone so far as to cut the price of their mid-size A350 in half in order to draw more demand. Nevertheless, a quick look at the share prices of these respective companies gives an even clearer picture: over the course of the past year, shares of EADS (producer of Airbus) have fallen nearly 22 percent while shares of Boeing have climbed 11 percent. The markets have spoken.
Other American exporters have gained from the weaker dollar as well. IBM saw stronger-than-expected quarterly profit growth on the back of a 13 percent jump in revenue from the Middle East, Europe, and Africa while US markets only saw a 1 percent gain. Meanwhile American firms like Al-jon Manufacturing LLC in Iowa have benefited from a jump in demand from Asia for scrap steel with a lengthy waiting list until the end of the year.
Not Everyone Wins When the Dollar Dwindles
Simple logic tells you that when someone wins in a deal, someone else has got to lose. As of last year, 70 percent of the goods Wal-Mart sold were produced in China. While the company has started to turn towards India for less pricey goods, there is only so much the American superstore can do to offset the implications of a dwindling dollar. European and New Zealand companies have also run into major pitfalls as the weakness of the US dollar drove the value of the Euro, British pound and New Zealand dollar higher. Corporate earnings for European companies, such as UK fashion group Burberry, were stellar for the second half of the fiscal year as demand for luxury goods have skyrocketed. However, the company reported that the British Pounds appreciation against not only the US dollar, but the Japanese yen as well, may slash revenues by a whopping 7 million pounds. Meanwhile, Paris-based LOreal saw revenues beat analyst estimates, with sales up 7.9 percent in the first quarter. The devil is in the details, though, as the sales figure does not account for exchange rate fluctuations. The rapid rise of the Euro during the quarter actually produced a negative 4.1 percent impact on sales.
The plunge of the dollar was perhaps worse for New Zealand companies, as the New Zealand dollar hit 25 year highs. Sanford, a fishing company based in Auckland, said that while demand out of Europe remained strong, exports to US markets plummeted as the companys catches were far more expensive. Furthermore, foreign exchange losses for the firm amounted to more than NZ$7 million, which decimated earnings for the second half of the fiscal year.
Déjà vu - A Repeat of 2004?
European companies are no strangers to the impact of a dwindling dollar. Back in 2004, a crunch of the greenback sent the Euro to a record high of 1.3667. As a result, exporters like Volkswagen, which has no production facilities in the US, making the company even more susceptible to currency fluctuations, had their earnings slashed as the automaker faced a loss of $1 billion in the US in 2004 alone. LVMH faced a similar debacle, as the luxury goods producer had their profits cut in half during the year due to foreign exchange losses. While these companies had no choice but to take the hit, other exporters decided to take action. Italy-based clothier Benetton announced plans in late 2004 to shift more factories outside of the Euro-zone to lower costs in order to compete with rivals such as H&M, whose manufacturing costs were in US dollars.
Japanese companies arent typically viewed as being as vulnerable to currency shifts since the yens value is extremely low relative to the US dollar. However, 2004 also represented harsh times for exporters like Nintendo. While sales did not suffer in the US market, where stores faced a shortage of consoles in the run-up to Christmas, the company revised profit forecasts early in the year down 39 percent on foreign exchange losses. Nintendo was particularly affected by the dollars plunge since it holds about $5 billion worth of dollar-denominated deposits, which need to be revalued every year.
While foreign exchange losses are still an issue for companies who export goods to the US, many of them have learned the importance of hedging these losses. After a rough 2004, Volkswagen increased hedging so that the company was 75 percent covered against a future drop in the dollar from 40 percent in 2003. Following the lead of Italys Benetton, Volkswagen opted to shift production out of Europe to Mexico, whose peso was more closely linked to the dollar. Meanwhile, Japans Nintendo cut back on the amount of assets held in US dollars.
Looking Ahead, Canada and the Europe Remain the Most Vulnerable
Nevertheless, foreign companies still face a certain amount of exchange rate risk, and Canadian and European companies could remain the most assailable. The US is by far the biggest trade partner of Canada, with 85 percent of the countrys exports shipped to the US last year. During the month of January, the Canadian dollar eased back to 14 month lows against the greenback, subsequently leading to a jump in exports to the US. However, the status of Canadas export sector may become increasingly precarious going forward, faced by the double-edged sword of commodity price and exchange rate risk. First, should commodity prices continue to ease back, the value of goods shipped out of the country could easily decline and erode Canadas trade balance. Furthermore, if the Canadian dollar appreciates more throughout the second quarter as it has done in the first, the countrys primary trading partner may cut back on purchases of Canadian products and undermine the strength of the economy as a whole.
Europe faces a similar dilemma, with export-dependant Germany at the forefront, as the hasty appreciation of the Euro against the US dollar helped drive the 2006 Euro-zone trade balance into deficit for the first time since 2000. While the German trade balance has been buoyed to 13.8 billion euros by demand from within Europe, deficits with Russia, China, and Japan have soared amidst gains in energy prices along with marked weakness of the Chinese Yuan and Japanese yen. As a result, Germany and other countries within the Euro-zone will face even more pressure to build up domestic demand in order to pick up the slack of the export sector.
If the US dollar begins to bottom out at current levels however, expect the relationship between the Dollar Index and the ratio of importers / exporters to hold. Except this time, a rise in the dollar will begin to help importers and hurt exporters. According to our chart, when the dollar index rallied from 82.50 to 85.25 in December 2006, the ratio of Wal-Mart / Boeing increased from 0.51 to 0.55.