Tuesday, September 15, 2009

"Favorable" Foreign Exchange...

By Sam Ro - …is one way of saying that a weak U.S. dollar helps boost quarterly revenue and earnings. This observation is made by companies with significant international sales and who report financial results in U.S. dollars.

This is an important consideration for equity investors using the S&P500 as their benchmark. According to Standard & Poor’s research, around 48% of S&P 500 company revenues are generated outside of the U.S.

So, I'd argue that the weak U.S. dollar partially explains why the S&P 500 has done so well in the last six months. In March, the S&P hit its low of the year when the dollar hit its high. When you overlay a chart of the S&P500, which is now trading at a year-to-date high, with the U.S. Dollar Index (DXY), which is now trading at a year-to-date low, you will easily notice the inverse correlation.

The U.S. dollar was actually at lower levels for much of Q3 2008, which means it should have an unfavorable impact on year-over-year comparisons this year. However, most corporate managers assume stable foreign exchange rates when issuing guidance. As such, if the U.S. dollar weakened since the last time earnings guidance was issued, Q3 2009 sales and earnings will be better-than-expected…ceteris paribus.

But based on the persistent divergence in stocks and the dollar, this may already be priced in.

If you’re unwilling or unable to sell your internationally exposed equity positions and you’re concerned that a rising dollar could eat into earnings, then you may want to hedge your position by going long the dollar. You can do so with an ETF like PowerShares DB U.S. Dollar Bullish Fund (UUP).