NEW YORK The U.S. dollar, long a friend to U.S. stocks with high exposure to international markets as the greenback remained weak, has turned into a headwind as the currency's fortunes have reversed, and companies with big overseas revenues are feeling it in the stock market.
That trend may continue throughout 2010, as strength in the dollar means international companies, which make up a large chunk of the S&P 500, are getting less dollars for their repatriated foreign revenues than before.
Companies in sectors such as technology and industrials are sailing against the currency tide as the euro nears a nine-month low against the greenback, and the stock market has noticed.
"Companies that generate most of their earnings outside of the U.S. have started to underperform relative to their domestic peers," said Paul Hickey, analyst at Bespoke Investment Group, a research firm in Harrison, New York. "As the dollar strengthens relative to the euro you're going to see companies in the U.S. with more domestic exposure do better."
That trend stands as a sharp contrast to last year when a falling greenback helped buoy U.S. companies that rely on overseas markets for much their revenue.
Shares of S&P 500 companies that get at least 50 percent of their revenues overseas outperformed those with U.S.-only business by about 32 percent from the start of 2009 to January 2010 as the dollar index slumped, according to Bespoke.
Since the dollar index has rise, companies that get all of their revenues inside the United States have performed better.
BIG TECH EXPOSURE
The average S&P 500 company generates about 45 percent of its revenue overseas, Bank of America-Merrill Lynch estimates, including direct and indirect exposure (through suppliers).
Bank of America-Merrill Lynch calculates that two thirds of the S&P 500's foreign exposure comes from cyclical sectors such as technology, energy, industrials and materials, making those companies more sensitive to global growth than U.S. growth.
International Business Machines Corp (IBM.N) gets just over 40 percent of its revenues from the Americas, so currency movements can have a big impact on results. In the fourth quarter IBM's revenues from Europe, the Middle East and Africa were $9.7 billion, for growth of 2 percent.
But if currency levels had been held constant year-over-year, revenue would have dropped 7 percent, so the falling dollar helped these results. Beginning in the first quarter, though, this is set to reverse.
The technology sector is the most heavily exposed to currency effects, with 60 percent of revenues coming from outside the United States, according to BofA-Merrill. Much of the international growth for those companies is in Asia, however, where the currency picture has been more stable.
THE DOLLAR'S IMPACT
Many dollar bulls view signs the U.S. Federal Reserve is reining in its easy policies, combined with weaker growth and high budget deficits in Europe, as a boost for the dollar.
The dollar's turnaround has been sharp. Since December the euro has dropped almost 10 percent against the dollar. That fall has been worse due to concerns that some euro zone governments may have difficulty financing high budget deficits.
The stronger dollar will erase $2 worth of earnings power from the S&P 500 this year, according to BofA-Merrill. The firm's currency strategists expect the euro to trade at an average $1.35 in 2010, falling to $1.28 by the end of the year, down from an average $1.40 in 2009.
"We expect the euro to depreciate versus the dollar further over the course of the year, said David Bianco, chief U.S. equity strategist at Bank of America Merrill Lynch. They estimate S&P 500 earnings will decrease 2 percent for every 10 percent decrease in the euro versus the dollar.
Merrill raised its 2010 S&P 500 earnings-per-share estimate by $2 to $75 and its 2011 forecast by the same amount to $85 due to a better earnings outlook for technology and consumer discretionary companies. But because of pressure from the dollar that view remains below consensus, says Merrill.
Carmine Grigoli, chief U.S. investment strategist at Mizuho Securities in New York, says at present levels the stronger dollar will start to affect S&P 500 earnings in the third and fourth quarter by about 1 to 2 percent, but he said that would be outweighed by other factors, such as pricing power and utilization levels.
"A strengthening dollar is positive for interest rate trends, and also for investments here into the U.S. and those factors would more than overwhelm the negative consequences of a drag on profits," said Grigoli.
(Editing by Leslie Adler)