Wall Street Is Blind to this Profit-Crushing Trend

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By Tony Sagami, Mauldin Economics:

Applied Materials. Boeing. Coach. Ford. Intel. McDonald’s. Nike. Pfizer. What do those household-name companies have in common? Not much, other than that a huge part of the sales come from outside the US.

Collectively, the 500 companies in the S&P 500 get 46% of their sales and roughly 50% of their profits from outside the US. They are truly multinational giants.

Expanding your customer base is always a good thing, but doing business overseas is not without peril, and one of the underappreciated perils is the impact of currency movements. A stronger dollar can hurt companies that do a large share of their business overseas because sales in other countries translate back into fewer dollars.

Just ask Procter & Gamble, which reported their Q4 results last week.

P&G sold $20.16 billion of toothpaste, laundry detergent, diapers, toilet paper, and razor blades last quarter, but that was a 4% decline from the same period a year ago. Worse yet, profits plunged by 31% to $1.06 per share, which was not only well below the $1.13 per share Wall Street was expecting but also a horrible 31% year-over-year drop. That’s bad.

What’s behind those terrible numbers? The US dollar.

“The October-December 2014 quarter was a challenging one with unprecedented currency devaluations,” said CEO A.G. Lafley.

The US Dollar Index was up 13% in 2014 and is now near a 9-year high. That strong dollar is a big millstone around the neck of US exporters, whose products are now more expensive for foreign buyers as well as negatively affecting profits once those foreign sales are converted back into US dollars.

Worse yet, Lafley said the environment will “remain challenging” in 2015.

The US dollar is now at a 9-year high and threatening to go higher. Much, much higher. By historical standards, the US dollar is still cheap and expected to go higher by many observers, including Procter & Gamble. P&G warned Wall Street that its 2015 sales will fall by another 5% and its 2015 profits will shrink by another 12%.

The strong dollar is a big problem for P&G because it gets roughly two-thirds of its revenues from outside the US, so it’s more affected by the strong US dollar than most companies, but P&G is far from alone when it comes to currency woes.

The line of companies that have warned that the strong dollar is hurting their profits is getting longer and longer. Microsoft, Pfizer, McDonald’s, Caterpillar, United Technologies, Emerson Electric, 3M, and even Walmart have warned that the rising dollar is depressing their profits.

What does this mean? That a LOT more companies are going to report lower-than-expected sales and profits in 2015 and those that do will see their stock get hammered, just like P&G.

The problem is that Wall Street is blind to this profit-crushing trend.

In 2014, the S&P 500 companies collectively earned $117.02, and the median forecast of Wall Street strategists for 2015 S&P 500 earnings is $126, which is an optimistic 7.6% growth in earnings.

Unless you think that Procter & Gamble is an isolated island of trouble (and it’s not), you should be very worried that Wall Street is grossly underestimating the profit-crushing impact of the strong dollar as well as grossly overestimating corporate America’s earnings growth. That massive disconnect between reality and the Wall Street dream world is going to translate into some very tough times for stock market investors. If you haven’t added some defense to your portfolio… you may need lots and lots of a popular Procter & Gamble product: Pepto Bismol.

By Tony Sagami. 30-year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here. To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here. This article was originally published at mauldineconomics.com.

What could go wrong? Hedge-Fund guru Paul Singer explains why they’re all doing it: a “wish not to be run over.” Read…  Immensely Concentrated Positions in “Fantastically” Overpriced Markets with “Unlimited Tolerance for Risk”

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  8 comments for “Wall Street Is Blind to this Profit-Crushing Trend

  1. NotSoSure
    Feb 3, 2015 at 11:32 pm

    600 points in two days say it all. Bad news is good news again.

  2. Jungle Jim
    Feb 4, 2015 at 1:02 am

    The writers logic is impeccable, but may not go far enough. Europe is showing signs of incipient deflation. That could lead to pricing pressure that would hammer profits still further. And yet, the markets are largely decoupled from and indifferent to such mundane considerations as business operations. They seem to respond to the Fed and damn little else. In that environment, bad news is really good news and vice versa. Where this will end is unclear, but we will be years cleaning up the mess that will result.

  3. Michael Gorback
    Feb 4, 2015 at 7:16 am

    Every other story now is about the strong dollar. Take a look at the S&P 500 vs the chart above. What did the stock market do starting in the mid-90s when the dollar surged 40%? It tripled.

    What did the stock market do during the 70s when the dollar sank? It sucked.

    There are several factors that have all hit at the same time. One is that it’s getting harder to find a developed country whose bonds still have a positive yield. A second is the safe haven. Another is Triffin’s Paradox which, among other things, says the issuer of the reserve currency has to run deficits to provide the world with sufficient reserves. If we have an oil glut and the price of imported oil goes down then there aren’t as many dollars being fed into the global system. There is also a self-fueling aspect as dollar shorts cover their bets and as debts denominated in dollars become more expensive. Weakening currencies will be fed into dollar denominated assets.

    I also suspect that if you dig under the headlines you’ll find that although FX was a problem, the bigger problem is sales. The rest of the world is slowing down significantly. Caterpillar blamed some of its earnings miss on FX but it said unequivocally that it was slowing in mining and oil that hit them hardest. Yet you see headlines like “Caterpillar, Microsoft, Procter & Gamble Suffer From Strong-Dollar Fever”.

    The fed took its foot off the pedal and the market is now driving yields. I have never seen anything to indicate that the fed ever saw this coming although there are some people who have been predicting this for 1-2 years.

    Like the drop in the price of oil, the strengthening dollar is a major signal that we’ve reached a turning point in the global economy.

  4. Petunia
    Feb 4, 2015 at 10:07 am

    The problem has more to do with income than Wall St wants to acknowledge. A middle class income doesn’t stretch into disposable income anymore. That middle class salary just keeps your head above water, it just covers the necessities. There is no extra in there for spending on full priced items. The money is going for housing, insurance, food, health care, and not much else. The other aspect is that consumers have learned to substitute out of necessity and are continuing the habit. This is happening everywhere not just in the US. Overall consumers shopping the sales will hit these companies over the long run. The only bright spot is the decrease in the cost of gas which is becoming that little extra money. This money is turning into the only increase in income most consumers have seen in years.

    • MC
      Feb 4, 2015 at 1:19 pm

      Bingo.
      Everything that cannot be purchased on credit is getting clobbered right now. So you get paradoxical situations like a car sales boom in countries where toothpaste sales are declining. Banks will be very happy to lend you money to help Ford shift metal but surely won’t lend you a dime to buy a tube of Colgate.

      I’ll add another related thing: don’t think the “fuel tax break” will last long. Prices at the pump will soon far outpace crude. The world has learned from Italy.
      In 2008, with oil prices in the $120/barrel region, gasoline was €1.450/liter. In 2015, with oil prices under $50/barrel, gasoline was exactly the same price. Deflation indeed.

  5. LG
    Feb 4, 2015 at 11:34 am

    There are no “markets” any longer! It’s a unicorns meet flying pigs.

  6. Peter
    Feb 4, 2015 at 12:03 pm

    Wall Street is a selling machine – bucket shops selling what they know will go down, with the position closed out for the customer at a loss. Wall Street has trained their customers to ignore real profits/losses and focus on revenue. They know what they are doing. The work hand and glove with the listed company managers.

    Every public business keeps two sets of books – those for the public to review; and those for senior management. The managers have to address reality and plan for the next 8 quarters. Every 90 days we have a bookkeeping reveal and public relations operation. None of that has anything to do with making money using the cash method and mark-to-mark balance method of accounting. There are no earnings/revenue surprises in business – this is all well-known and well-planned (on the upside and the downside).

    If you want to hold tight to your money, exit wall street. Buy residential rentals, royalty streams from patents, trademarks, copyrights and wells. Just know what you are getting involved in. If you can not bother with the details, then forget it. Hold bullion and cash and focus your efforts in staying debt-free and banking surplus.

  7. Christoph Weise
    Feb 4, 2015 at 3:40 pm

    The exchange rate is only part of the picture. If GDP figures were adjusted to account for forged CPI and and forged GDP (inclusion of revenues from illegal activities) US would be officially in a recession. If GDP figures were further adjusted to subtract revenues from unsustainable debt expansion US would be in an outright depression. This is mirrored by disastrous average family income, average family debt ad average family net assets figures. US is quickly approaching the level of a BRICS country. The american optimism as regards the so-called recovery is difficult to understand, maybe a phenomenon of missguided mass-perception. There is certainly an over-estimation or over-apprecation of stock price development. Stock prices as such are by no means an indicator of wealth it is rather an indicator of inflation. The fungibility is restricted which will become obvious as soon as enough people try to get rid of their overpriced Tesla or Google shares.

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