A February 10th report from Goldman Sachs Research argues that despite the dollar strengthening throughout much of the second half of 2014, U.S. corporate profits for Q42014 and 2015 still look reasonably strong.

GS analyst David Mericle and team note: “US foreign profits have historically been negatively correlated with dollar strength, and some companies noted substantial hits last quarter.But the impact on profits in 2014Q4 appears more limited than the impact on sales, likely reflecting increases in hedging and production abroad by US companies.”

Strong Dollar Corporate Profits

Strong dollar only a mild headwind for U.S. firms

The analysts note that S&P 500 profit margins are likely to end 2014 lower than 2013, due to “dollar appreciation, a lack of productivity growth, lower financial profits, and higher effective tax rates.” That said, they expect margins to remain at current levels in 2015, with increased foreign demand offsetting the stronger dollar. Mericle et al. also argue a that a “healthier rebound in productivity offers potential upside.” However, on a longer two-to-three year timeline, margins will probably slip as wage growth moves up to the 4% range.

Strong Dollar Corporate Profits

Strong dollar expected to result in 2.5% decline in S&P 500 total profits

Mericle and colleagues point out that guidance from S&P 500 firms to date suggests a 3­.5% hit to total profits as a result of dollar appreciation in the fourth quarter of 2014. This would imply an overall hit of 2.5% to corporate profits.

Strong Dollar Corporate Profits

These estimates are really more like an upper bound, according to the GS analysts. For starters, firms that have already reported fourth quarter results are not showing large profit decreases. They point to Exhibit 3: “Exhibit 3 shows that companies with higher foreign revenue exposure have seen a more substantial hit to revenues than to earnings (admittedly, these relationships should be weaker to the extent that domestic sales also compete with cheaper imports, but the decline in import prices so far has been modest relative to dollar appreciation).”

The Goldman Sachs report highlights two reasons for the relatively limited hit to earnings from the stronger dollar. First, almost all large U.S. firms today hedge their foreign exchange exposure. Second, American firms are producing a major portion of their products abroad today, meaning that lower costs offset weaker sales.

Strong Dollar Corporate Profits