Dollar’s Fall Could Help Lift Blue Chips
For U.S. blue-chip stocks, the slumping dollar appears to be that rarest of commodities these days: good news.
So far, the dollar’s fall--which deepened on Thursday, with the greenback hitting a two-year low against the euro--isn’t offsetting other negatives that are dragging share prices lower.
Indeed, Wall Street fell sharply again Thursday, pushing key indexes to eight-month lows.
But the stock market’s bulls say the dollar is one trend that is going in the right direction.
McDonald’s Corp., the world’s largest restaurant chain, said this week that its second-quarter profit would climb after six straight quarterly declines, in large part because of the strength of the euro, which has rallied about 10% against the dollar since early April.
Goodyear Tire & Rubber Co., meanwhile, this week raised its second-quarter profit forecast, citing cost-cutting moves but also noting that the stronger euro would give a modest boost to the bottom line.
“We’re likely to hear more favorable comments, especially from the big companies,” said Gary Thayer, an economist at brokerage A.G. Edwards & Sons in St. Louis.
When the dollar weakens, U.S. firms with overseas operations can automatically benefit as foreign income translates into more dollars. In addition, U.S. companies that export products have the flexibility to cut prices, which may make them more competitive with foreign rivals, or to keep prices the same in dollar terms, which gives them more foreign currency in return.
By contrast, a strong dollar--which has been the norm since 1998--is a drag on U.S. companies’ foreign results.
The dollar’s reversal this year against key currencies has been blamed on factors including concern about U.S. accounting standards, worries about the economic recovery and jitters over the massive U.S. trade deficit, which ballooned to a record $35.9 billion in April, a report Thursday showed.
All of those issues have tarnished the dollar’s image as the world’s dominant currency and have made foreigners less interested in investing in U.S. assets, analysts say.
The trade deficit report triggered another surge in the euro Thursday, lifting its value to a two-year high of 96.5 cents from 95.7 cents Wednesday. The dollar also has tumbled this year against the British pound, the Australian dollar and the Japanese yen, among others.
The dollar may be only “about halfway through” its downtrend, said economist Thayer, who believes it remains overvalued relative to other major currencies.
In a report Thursday, mutual fund firm Putnam Investments said the euro probably would continue to be the main beneficiary of the dollar’s weakness--not just because of optimism about Europe’s prospects for an economic rebound, but also because the euro is seen as the leading alternative to the dollar as a store of value for global investors.
If the dollar’s slide continues, consumer-oriented multinational companies such as McDonald’s, Procter & Gamble Co., Coca-Cola Co. and Colgate-Palmolive Co. could get a substantial profit bump in the second half of the year, said Chuck Hill, research director at Boston-based earnings tracker Thomson First Call.
“They got hurt back in 1998 when the dollar strengthened. Now it’s working the other way,” Hill said.
A falling dollar typically works to the advantage of larger companies over smaller ones, because big firms are more likely to do significant business overseas. In the blue-chip Standard & Poor’s 500 index, for example, about 26% of total company revenue comes from foreign markets. In sectors such as technology, energy, basic materials and consumer staples (toiletries, food and so forth), that percentage is even higher.
But changes in currency values can affect any company that exports products or does a lot of business abroad, including some small and mid-size firms. Examples include Tupperware Corp., Dole Food Co., BE Aerospace Inc. and packaging maker Chesapeake Corp., each of which does more than half its business abroad, according to brokerage Salomon Smith Barney (the firm does not necessarily recommend those stocks, however).
On the flip side, some major companies that have hefty foreign sales may not necessarily reap big benefits from currency swings. Hill notes that many companies hedge against currency fluctuations through trading strategies that can minimize the effect of dollar changes, good and bad.
Also, not all companies will be affected by the dollar’s slide as quickly as a “cash-and-carry business” such as McDonald’s, said Sung Won Sohn, chief economist at Wells Fargo & Co. in Minneapolis. Companies that make big-ticket goods, such as Caterpillar Inc., may get more of a delayed benefit, Sohn said, because shipping, billing and other steps take time.
Still, after seven years of a mostly upward trend, a decline in the dollar is probably positive for U.S. companies and, eventually, for the stock market, analysts say.
There are major risks, however.
Goldman, Sachs & Co. economist William Dudley noted in a report last week that the 1985-88 experience illustrated how a falling dollar can worsen the U.S. economic climate in the near term. After peaking in March 1985, the dollar began a three-year slide that destabilized U.S. markets, helping to fuel a spike in Treasury bond yields that was one trigger for the 1987 stock market crash.
This time around, a continuing drop in the dollar could make foreign investors increasingly reluctant to own dollar-denominated stocks and bonds, analysts say. If that begets wholesale dumping of U.S. assets, the immediate effect on Wall Street may be more of the same--falling share prices.
For U.S. consumers, there may be a downside as well, Thayer said: Imported products such as apparel and electronics can become more expensive as the dollar weakens. Also, U.S. firms could have more leeway to raise prices domestically if prices of foreign goods rise.
And, of course, any overseas vacations Americans are planning are becoming more costly by the day.
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