Troubling Signs for the U.S. Economy and its Corporations
August 20th, 2008One year ago in “How Good Were 2Q Earnings Really?” I wrote:
…we should think carefully (and critically) about why some firms performed well…especially those that used improved foreign sales as an explanation for such performance.
If consumers continue to struggle in the US and it turns out that the improvement in…performance was a result of a temporary improvement [exchange rate induced] in the repatriation of foreign profits, we can and should expect…a long road to economic recovery.
Two things (not unrelated) have happened since then that make that prognostication look more and more like a reality:
1. In addition to the U.S. consumer struggling at home, consumers across the globe (especially in Japan and Europe) have begun to feel strain, resulting in decreased foreign demand for U.S. goods and services. For an excellent summary of economies currently in (or slipping into) recession, see Nouriel Roubini’s recent post The Perfect Storm of a Global Recession.
The argument for some time had been that although domestic demand was stagnating, global growth would keep the U.S. economy (and the performance of its firms) chugging along, with increased exports substituting for domestic consumption. With a global consumer now struggling, and global growth quickly slowing, that reasoning looks tenuous. Re-coupling seems to be the order of the day.
2. The U.S. dollar has rallied significantly in recent weeks (by about 10% in DXY terms). This is a trend that I see continuing for awhile.
In my opinion, the explanation for the dollar’s strength has to do with the fact that now that many economies outside the U.S. are struggling, it is becoming increasingly clear that foreign countries will not only NOT be able not to raise interest rates to curb inflation, but will eventually HAVE to lower interest rates to address their own domestic weakness. This change in expectations for foreign central bank interest rates is U.S. dollar supportive. Add to that the flight to quality that generally occurs when foreign economies weaken, and we have a recipe for a sustained U.S. dollar rally. Mish has provided some excellent insight on the dollar in recent weeks (see U.S. Dollar Rally Continues, Currency Intervention and Other Conspiracies)
Should the U.S. dollar continue to strengthen vis-a-vis foreign currencies (and I expect that it will), it will put additional pressure on the earnings potential of U.S. multinationals that benefited from favorable exchange rates. A strengthening dollar not only makes U.S. goods and services more expensive for foreign consumers to purchase in their own currency, but it lowers earnings via the repatriation channel – the consolidation and reporting of foreign profits in U.S. dollar equivalents.
Taken together then, in addition to a struggling U.S. consumer, U.S. corporations face several additional headwinds moving forward: Foreign consumers that are now struggling – not willing, or able, to purchase U.S. goods and services – and less of a repatriation windfall as well.
Ouch!
