As we head into the heart of second quarter earnings season, the S&P 500 is anticipated to post rather dismal earnings results given some familiar headwinds: 1) a strong US dollar, 2) volatile commodity prices and 3) lackluster economic growth.
Considering these issues, we view the dollar as the one headwind that could potentially provide upside to current estimates, beyond standard beat rates. Trends in the US dollar coupled with the timing of corporate guidance projections form the basis of our suspicion. If this theory pans out, the information technology sector stands to benefit the most given its outsized exposure to foreign sales and sensitivity to fluctuations in dollar exchange rates.
While the US Dollar Index (DXY) remains 20% above year ago levels, it has retraced 4.8% from its March 13th high and has weakened 3.3% since Q1 tech earnings season kicked-off when Intel announced results on April 14th.
US Dollar Index (DXY) January 2015 – June 30, 2015
The year-over-year appreciation, however, has kept Wall Street analysts bearish on corporate profitability. Recall that analysts cut estimates rather dramatically for all four quarters and the entire year ahead of first quarter earnings season in anticipation of ongoing dollar strength, as well the economic slowdown, plunge in oil prices and West Coast Port closure. While the first quarter ended up locking in growth at 3.2%, 650 basis points ahead of expectations, estimates were still reduced further for the remaining quarters of 2015.
Accenture (reported on June 25th) is the first example of a tech company overestimating the dollar’s impact on the most recent quarter. This prompted us to dig a little further into the assumptions other tech management teams were using with regards to currencies.
We found many CFOs relied on spot rates at the time Q1 results were announced and Q2 guidance was provided in mid-April through early May when the dollar remained strong.
Considering that the dollar has weakened slightly since corporate guidance was provided, we suspect that currency fluctuation could be less of a headwind to earnings in the second quarter compared to what is currently implied according to fairly lackluster consensus earnings expectations from Wall Street analysts.
Further detail on specific company guidance and the effect of tech sub-sectors can be found in this detailed report.