Strong dollar may hit profits, kill stock rally

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, Abbott Laboratories and AbbVie, La Monica does not own positions in any individual stocks.

The U.S. dollar is looking pretty strong lately, compared to the yen and the euro. While that might sound like great news, it could actually put the market rally in jeopardy.

Corporate profits could take a hit in the first quarter if the greenback keeps bulking up. In fact, software giant Oracle (ORCL) said Wednesday that its latest quarterly sales and earnings would have been better if the dollar hadn't strengthened as much as it did during the last three months of 2013.

The hit to earnings wasn't that dramatic. But Oracle's results missed forecasts and the punishment was brutal. Shares plunged nearly 10% Thursday morning.

And there are no signs that the dollar will pull back anytime soon.

The U.S. Dollar Index, which tracks the greenback against the euro, yen and four other major currencies, has gained nearly 4% so far this year, and is not far from its 52-week high. Such a move may not sound like much but it is pretty dramatic in the world of forex.

 
If this trend continues, scores of blue chips with large chunks of revenue coming from international markets could all report currency-related hits to their sales and earnings when they announce first-quarter results next month. That's bad news, considering that analysts already have pretty weak forecasts for corporate profits this quarter.

According to John Butters, senior earnings analyst with FactSet Research Systems, profits for companies in the S&P 500 are expected to dip about 0.6% in the first quarter from a year ago. At the start of the year, analysts had been expecting an annual earnings increase of 2.2%.

Considering that stocks have largely been rallying on hopes of healthy profits, despite sluggish economic growth in the U.S. and Japan and a recession in most of Europe, the fact that estimates are coming down is not a good sign.

Related: What's next for the markets?

Butters pointed out that consumer products makers Procter & Gamble (PG) and Newell Rubbermaid (NWL), energy giant Chevron (CVX), drug developers Merck (MRK) and Pfizer (PFE) and tech titans Microsoft (MSFT) and Amazon (AMZN) all discussed the stronger dollar as being a negative in the fourth quarter.

He believes more companies will say it's an even bigger concern in the first quarter. And the impact could be broad.

A strong dollar hurts large U.S. companies in two ways. First, the value of sales from overseas wind up being reduced once they are translated from weaker foreign currencies back into dollars. In addition, a stronger dollar makes it tougher for American multinationals to compete with global rivals since the price of exported goods and services rise with the value of the dollar.

Concerns about pricing and export demand are exactly why Japan has taken aggressive steps to devalue the yen this year. That's likely to continue. And shares of several leading Japanese companies, such as Sony (SNE), Toyota Motor (TM) and Panasonic (PC)  have all rallied in 2013 on hopes that the suddenly puny yen will boost sales and profits of their products abroad.

Related: Japan's economy begins to grow again

Japan's actions have sparked worries of a currency war as well. So far, the U.S. is losing that battle -- even though the Federal Reserve's quantitative easing policy of buying bonds to keep long-term rates low should help lower the value of the dollar.

But the problem for the Fed and U.S. companies is that QE won't really dent the dollar that much as long as Japan is being even more proactive and Europe remains in crisis mode.

Fears of what could happen if Cyprus is forced to leave the eurozone are helping push down the euro's value against the dollar and other currencies. Cyprus is in serious trouble after its bailout was nixed due to criticism of a bank deposit tax that was a condition of the rescue.

Related: Clock is ticking to save Cyprus bailout plan

The U.S. is once again being viewed as a relatively safe haven among developed markets. The dollar may not necessarily be healthy -- especially since politicians in Washington are doing their best to weaken the economy by refusing to compromise on a budget deal -- but it is the least sick of the major currencies.

The dollar has a cold. Japan has pneumonia. And the euro might succumb to the bubonic plague if Cyprus gets the boot and ignites fears of bank runs and more economic chaos in Greece, Italy and Spain.

So unless you're planning a trip to Europe or Japan this spring, it may not be wise to root for a stronger dollar. If more companies get hurt like Oracle did, it's going to be a lot harder for the stock market to remain near record highs.

Wall Street Hits Record High; Main Street Still in Stagnation "What's Up"

While America is in the midst of the weakest economic recovery since the Great Depression, the 
stock market is soaring towards record levels. Dow Jones just hit 14,000 for the first time since October 2007.

Huffington Post reported on the disconnect between Dow Jones’ and the rest of the economy’s performance:

The best-known stock-market average in the world is at an all-time high. Unfortunately, that matters less than it ever has.

A new high for the Dow Jones Industrial Average is an important milestone on the road to recovery, no doubt. The stock index has more than doubled from its low in March 2009, making this one of the strongest bull markets in history. At the same time, regular people have hardly benefited.

 

A snapshot of economic indicators from today’s headlines comparing the last time the Dow was over 14,000 [in October 2007] can be found at ZeroHedge (select):

• Dow Jones Industrial Average: Then 14164.5; Now 14164.5
• Regular Gas Price: Then $2.75; Now $3.73
• GDP Growth: Then +2.5%; Now +1.6%
• Americans Unemployed (in Labor Force): Then 6.7 million; Now 13.2 million
• Americans On Food Stamps: Then 26.9 million; Now 47.69 million
• Size of Fed’s Balance Sheet: Then $0.89 trillion; Now $3.01 trillion
• US Deficit (LTM): Then $97 billion; Now $975.6 billion
• Total US Debt Outstanding: Then $9.008 trillion; Now $16.43 trillion
• Labor Force Participation Rate: Then 65.8%; Now 63.6%
• 10 Year Treasury Yield: Then 4.64%; Now 1.89%
• Gold: Then $748; Now $1583

While the news isn’t all bad, since corporations have been hoarding money due in part to an uncertain business environment, and thus could potentially employ that money if the economy settled down, there are some serious challenges ahead of the country, namely:

• GDP growth below expectations (including 0.1% contraction in 4Q 2012).
• Troubling financial news in Europe.
• Potential unwinding of Federal Reserve balance sheets.
• The dissolution of stimulus spending.

In other words, the market is being propped up by The Fed’s liquidity along with debt-spending by the U.S. government (46 cents of every dollar spent by the government is borrowed). And news reported by Business Insider has it that The Fed is preparing for the public relations “nightmare” when it halts “payments to the Treasury from the interest income it receives on its bond portfolio.”

As a Deutschebank strategist cited in the BI article points out, the suspension of remittances and carrying unrealized losses “would leave a private company technically insolvent. It is unclear how Washington and the public might react to these circumstances and whether the Fed’s independence might be challenged.”

In plain English, what is going on in the economy, and what role does The Fed have in it?

Imagine you have a bowl of stew that has been simmering all day on low at a cheap all-you-can-eat buffet (gross, right?). Every once in a while Chef Producero throws in some new meat, while Chef Bernanko adds some broth. Over the course of the day, Chef Producero is putting in less meat, while Chef Bernanko keeps watering down his broth. Meanwhile, the soup stock is filling up nearly to the top. What is happening to the stew?

What is happening to the stew is what’s happening to the economy: a record stock market with a sluggish productive sector, that’s what. Not very appetizing, is it?

The only good thing about the current situation for main-street is low mortgage rates that allow home owners & home buyers to lock into low fixed interest rates and protect themselves from the coming inflation curves that are sure to come after the party is over on all the cheap printed money that the Federal Reserve has pumped into the system.