The dollar’s drag on corporate profits is set to die away soon.
In the past year, the US dollar index, which measures the dollar against a basket of other currencies, has been on an amazing tear and rallied about 20%.
The largest S&P 500 companies that generate a chunk of their sales in weaker, foreign currencies, see those earnings shrink when they are translated back to the dollar.
But in a note to clients Friday, Fundstrat’s Tom Lee wrote that these so-called “FX headwinds” companies have grumbled about for the last several quarters are now set to decline soon.
“Based on current trajectory of DXY [the US dollar index], about one-third of this drag will reverse in early 2016, meaning USD goes from being a headwind to a tailwind,” Lee wrote.
Lee noted that the biggest hit to earnings this year will come in the third quarter. Based on data from FIREapps, Lee said the dollar’s strength is having about a $US93.5 billion, or $US10.11 per share, impact on S&P 500 earnings.
Excluding the dollar impact, S&P 500 profits grew by about 8% this year, or $US9.64 per share.
Lee wrote that this basically counters the notion that US corporate profits are in a recession.
“We believe expectations are sufficiently beaten down for 3Q15, and that the risk/reward is pretty favourable for earnings season,” Lee wrote. “The upshot of this is that we believe models and forecasts were based on a January 2015 dollar, which has since weakened. Thus, we see wiggle room for EPS increases as we move into 2016.”
The other good news for companies, according to Lee, is that the drag from lower oil prices is also set to fade.