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Earnings: At the Mercy of a Mercurial Dollar

Investors in U.S. stocks were celebrating the weak U.S. dollar last year. Now that the buck has strengthened, it's payback time.

For the first half of 2008, the dollar was stuck in the doldrums, but that was good news for U.S. companies. While their domestic market was in recession, U.S. firms could report big sales figures from abroad. Sales made overseas in expensive euros or pounds looked that much larger when brought back home and converted into cheap dollars.

That changed dramatically in late 2008 when the financial crisis heated up and it became clear that the economic slowdown would be global. The U.S. dollar index, a measure of the greenback against a basket of foreign currencies, jumped more than 20% in four months, peaking in late November.

Fourth-Quarter Earnings Suffer

This fourth-quarter currency whiplash should show up dramatically in end-of-the-year financial results. The fourth-quarter earnings season officially starts on Jan. 12, when Alcoa (AA) reports results.

Investors already have been given previews of the damage from the dollar's comeback:

Oracle (ORCL) earnings per share were flat in its second quarter, but earnings would have risen 11% without the dollar's rebound, the software firm said Dec. 18. Almost half of Oracle's sales in the quarter came from outside the Americas.

Wal-Mart Stores (WMT) disclosed Jan. 8 that its international revenue would have risen 8.3% in December if not for the strong dollar. Instead, last month's international sales plunged 10.4%—a $2.2 billion bite out of the world's largest retailer's sales.

General Mills (GIS), which reported results Dec.19, saw the impact of currency shave eight percentage points off sales growth for its international business. International sales still managed to rise 2%.

Best Buy (BBBY) said Jan. 9 that foreign currency exchange rates cut international sales by 16 percentage points.

Carnival Cruise (CCL) said Dec. 8 that net revenue yields—a measure in the cruise industry of revenue compared to available ship capacity—would be off 11% to 15% in 2009 through changes in exchange rates.

Lowered Overseas Costs, Higher Commodity Prices

The stronger U.S. dollar isn't all bad news for U.S. firms. Their expenses abroad are also falling. Even as Alcoa announced it was cutting 13,500 jobs, the aluminum company also said it would need to spend $150 million less to finish a mine and refinery in Brazil—because of "efficiencies and a strengthened U.S. dollar."

That's small comfort to a company like Alcoa, however, because of the trouble a weak dollar causes for commodity prices. "Companies that are hurt most by a rising dollar tend to be commodity companies," says John Derrick, director of research at U.S. Global Investors (GROW). "Typically, commodities perform inversely to the dollar."

The Dollar's Uncertain Future

The world currency market is infinitely complex and notoriously unpredictable. A vast array of factors drive the relative value of currencies. Market analysts watch trade balances between countries, investment flows, the setting of interest rates, government fiscal policy, and economic growth rates, among other data points.

At the beginning of 2008, when the dollar was weak, some were questioning whether the dollar could continue as the world's dominant currency. Then the financial crisis intensified.

"What the crisis revealed is there was really a shortage of dollars," says Marc Chandler, chief currency strategist at Brown Brothers Harriman.

Though the financial crisis started in the U.S., cash in the world's dominant currency—the U.S. dollar —became a safe haven for investors fleeing riskier investments and currencies. "During times of major global weakness, the U.S. dollar tends to outperform other major currencies," says Brian Dolan, chief currency strategist at, the online trading unit of Gain Capital Group.

It's clear that fourth-quarter U.S. profits will be hurt by the strong dollar. But as 2008 proved, the currency markets can change quickly. The dollar actually lost strength in December before rebounding into the New Year.

A key question for U.S. corporate profits, then, is where the U.S. dollar moves from here.

Chandler and Dolan both predict the dollar will remain relatively strong despite economic problems in the U.S., mostly because the rest of the world is also doing poorly.

Though the U.S. was the first into recession, it may be the first out of it, Chandler says, citing aggressive moves by the Federal Reserve and a big economic stimulus bill planned by President-elect Barack Obama. While the Fed has already slashed rates, central bankers in Europe and elsewhere still have rates to cut. Europe may have a more prolonged recession than many initially expected, he says.

The combination of a weakening economy and falling interest rates tend to hurt the value of a currency, and it looks like it could be the European Union's turn for a while. Currencies of emerging economies have also been hurt by these trends, with falling commodity prices especially painful in places like Brazil and Russia.

After trending lower most of the decade, "now the dollar has begun a multiyear bull market," Chandler says.

Inflation Risks

Derrick, of U.S. Global Investors, recognizes the strength of the dollar in the short term. But he worries about the federal government's expensive efforts to stop the financial meltdown. So much spending and free credit now will hurt the strength of the dollar in the long term, he says. "I think inflation will be the story for 2010 and probably beyond."

Dolan disagrees. With widespread economic problems, he's less worried about inflation hurting the U.S. dollar. "Inflation only really becomes an issue when there's demand there to drive it," Dolan says, citing many economic problems in the U.S.—from a weak housing market to rising unemployment—that are likely to linger.

Expect the volatility that roiled currency markets in 2008 to continue, Chandler says. With economic conditions changing so fast, the dollar is likely to bounce around like a yo-yo on a string.

That adds one more difficulty to U.S. companies'—and investors'—efforts to predict where earnings will head in coming years.

Steverman is a reporter for BusinessWeek's Investing channel.

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