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Strong dollar may hit profits, kill stock rally

March 21, 2013: 12:59 PM ET
The dollar has bulked up while the yen and euro have weakened. This could hurt profits for major U.S. companies.

The dollar has bulked up while the yen and euro have weakened. This could hurt profits for major U.S. companies.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, Abbott Laboratories and AbbVie, La Monica does not own positions in any individual stocks.

The U.S. dollar is looking pretty strong lately, compared to the yen and the euro. While that might sound like great news, it could actually put the market rally in jeopardy.

Corporate profits could take a hit in the first quarter if the greenback keeps bulking up. In fact, software giant Oracle (ORCL) said Wednesday that its latest quarterly sales and earnings would have been better if the dollar hadn't strengthened as much as it did during the past three months.

The hit to earnings wasn't that dramatic. But Oracle's results missed forecasts and the punishment was brutal. Shares plunged nearly 10% Thursday morning.

And there are no signs that the dollar will pull back anytime soon.

The U.S. Dollar Index, which tracks the greenback against the euro, yen and four other major currencies, has gained nearly 4% so far this year, and is not far from its 52-week high. Such a move may not sound like much but it is pretty dramatic in the world of forex.

If this trend continues, scores of blue chips with large chunks of revenue coming from international markets could all report currency-related hits to their sales and earnings when they announce first-quarter results next month. That's bad news, considering that analysts already have pretty weak forecasts for corporate profits this quarter.

According to John Butters, senior earnings analyst with FactSet Research Systems, profits for companies in the S&P 500 are expected to dip about 0.6% in the first quarter from a year ago. At the start of the year, analysts had been expecting an annual earnings increase of 2.2%.

Considering that stocks have largely been rallying on hopes of healthy profits, despite sluggish economic growth in the U.S. and Japan and a recession in most of Europe, the fact that estimates are coming down is not a good sign.

Related: What's next for the markets?

Butters pointed out that consumer products makers Procter & Gamble (PG) and Newell Rubbermaid (NWL), energy giant Chevron (CVX), drug developers Merck (MRK) and Pfizer (PFE) and tech titans Microsoft (MSFT) and Amazon (AMZN) all discussed the stronger dollar as being a negative in the fourth quarter.

He believes more companies will say it's an even bigger concern in the first quarter. And the impact could be broad.

A strong dollar hurts large U.S. companies in two ways. First, the value of sales from overseas wind up being reduced once they are translated from weaker foreign currencies back into dollars. In addition, a stronger dollar makes it tougher for American multinationals to compete with global rivals since the price of exported goods and services rise with the value of the dollar.

Concerns about pricing and export demand are exactly why Japan has taken aggressive steps to devalue the yen this year. That's likely to continue. And shares of several leading Japanese companies, such as Sony (SNE), Toyota Motor (TM) and Panasonic (PC) have all rallied in 2013 on hopes that the suddenly puny yen will boost sales and profits of their products abroad.

Related: Japan's economy begins to grow again

Japan's actions have sparked worries of a currency war as well. So far, the U.S. is losing that battle -- even though the Federal Reserve's quantitative easing policy of buying bonds to keep long-term rates low should help lower the value of the dollar.

But the problem for the Fed and U.S. companies is that QE won't really dent the dollar that much as long as Japan is being even more proactive and Europe remains in crisis mode.

Fears of what could happen if Cyprus is forced to leave the eurozone are helping push down the euro's value against the dollar and other currencies. Cyprus is in serious trouble after its bailout was nixed due to criticism of a bank deposit tax that was a condition of the rescue.

Related: Clock is ticking to save Cyprus bailout plan

The U.S. is once again being viewed as a relatively safe haven among developed markets. The dollar may not necessarily be healthy -- especially since politicians in Washington are doing their best to weaken the economy by refusing to compromise on a budget deal -- but it is the least sick of the major currencies.

The dollar has a cold. Japan has pneumonia. And the euro might succumb to the bubonic plague if Cyprus gets the boot and ignites fears of bank runs and more economic chaos in Greece, Italy and Spain.

So unless you're planning a trip to Europe or Japan this spring, it may not be wise to root for a stronger dollar. If more companies get hurt like Oracle did, it's going to be a lot harder for the stock market to remain near record highs.

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Paul Lamonica
Paul R. La Monica
Assistant Managing Editor, CNNMoney

Paul R. La Monica is an assistant managing editor at CNNMoney. He is the author of the site's daily column, The Buzz, and also tweets throughout the day about the markets and economy @LaMonicaBuzz. La Monica also oversees the site's economic, markets and technology coverage.

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