Alcoa kicked off what’s expected to be a dismal second quarter earnings season on Wednesday with a relatively solid report. Currency headwinds in particular have been weighing on U.S.-based international companies, especially tech firms, but those headwinds could be abating as the strength of the U.S. dollar begins to fade slightly.
U.S. dollar switching to tailwind?
Between the strengthening of the U.S. dollar, volatility in the commodity price market and weak economic growth, the S&P 500 just isn’t expected to post strong earnings. Overall, the index is expected to post a decline of 4.3% in earnings for the second quarter. But one of the trio of headwinds is starting to abate and, in fact, could become a tailwind for many companies in the information technology sector.
Lindsey Bell, senior analyst at S&P Capital lQ, says when paired with the timing of guidance from S&P 500 companies, U.S. dollar trends could end up being a tailwind instead of a headwind. This is especially true of the IT sector, as more than 56% of its sales are international. The entire S&P 500 Index has an exposure of 46% to international markets. (Graph is courtesy S&P Capital IQ.)
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The U.S. dollar remains high…
Bell notes that the U.S. dollar remains 20% higher compared to this time last year, however, which would usually mean that it would be a headwind for internationally-exposed companies. Indeed, the dollar weighed heavily on first quarter earnings for S&P 500 companies.
Analysis from S&P Capital IQ suggests that between earnings results for companies in the index were reduced by between 5% and 6% during the quarter because the U.S. Dollar Index climbed 9% in the first part of this year. Since hitting its high on March 13, the index has “retraced” 4.8% and declined 3.3% since Intel released its earnings report on April 14, kicking off earnings season for the IT sector. (Graph is courtesy S&P Capital IQ.)
But the U.S. dollar has weakened slightly
Year over year, the U.S. dollar was 19.7% higher as of the end of June. For the quarter, it's 19.9% higher. These increases are why analysts from most firms have been so bearish on the markets. Bell noted that analysts recently slashed their estimates for all four quarters this year before first quarter earnings season because of the stronger dollar and also a slowdown in the economy, falling oil prices and the closure of the West Port.
She also pointed out that the first quarter posted growth of 3.2%, beating expectations by 650 basis points. However, analysts still tended to reduce their estimates for the next three quarters.
The analyst also noted that most S&P 500 companies provided guidance in mid- to late April using the trends at that time. However, the U.S. dollar has weakened slightly since then. This is a big reason she expects currencies to become a small tailwind for second quarter earnings reports rather than a headwind.
Tech earnings: Facebook, Twitter to benefit from currency tailwind
Cantor Fitzgerald analysts Youssef Squali, Naved Khan and Kip Paulson also suggested that currencies could be a small tailwind rather than a headwind for second quarter earnings reports. Companies that will especially benefit from the slight weakening in the U.S. dollar include Facebook, Twitter, Google, Amazon and eBay, among others. The Cantor Fitzgerald team noted that about 55% of Facebook's and Google's revenues are international, while about 36% of Twitter's, 40% of Amazon's, and 53% of eBay's revenues are international. (These charts are courtesy Cantor Fitzgerald.)