America’s biggest corporations have revealed their overall earnings for the first quarter and profit growth is looking arguably stagnant in comparison to previous years.
Many analysts are now trying to define how the recent economic climate in the US is affecting businesses both big and small.
The global economic status is in recovery, and despite an encouraging outlook for Europe and restrained growth in the Chinese markets, it’s proving to be a slow start for America.
Strategists at S&P Capital IQ and The Bank of America Merrill Lynch are marking 2015 as the year of a possible profit recession, with the worst drop in earnings since 2009. They outline three potential causes:
- The 50% drop in the price of crude oil, and its severe impact on the energy sector (down 65%),
- The rise of the American dollar since last June (20%) and its effect on the multi-national corporations and members of the S&P (Standard & Poor) 500 index,
- And last, but by all means least – they’re also blaming the recent year’s bad weather.
In economic terms two consecutive negative quarters generally tend to constitute a recession, S&P Capital IQ expects the first quarter to show a loss of 2.92% followed by the second at a loss of 1.84%.
Strategist for S&P Capital IQ, Sam Stovall states that these negative earnings trends and economic recessions tend to ‘go hand-in-hand’.
Even though it’s not officially a ‘profit recession’ he states that ‘the full-year growth estimate is getting uncomfortably close to that threshold’.
Labelled ‘King dollar’, the US bank note has been on the rise proving strong against other major foreign currencies in recent months.
To put it in perspective on the 31st December 2014, one euro was equal to 1.21 USD, but today, one euro is worth approximately 1.09 USD, gaining 20% over a 12 month period.
The strong dollar is an indication of a more resilient U.S economy, however it has also has an overwhelming effect on US earnings, creating difficulties in foreign trade.
Times are proving tough for U.S. companies who generate a proportion of their profit overseas – their foreign market revenue loses value during the conversion process and the cost becomes less competitive (in comparison to businesses operating in countries with declining currencies).
Sparking fear of an ‘earnings recession’, this year’s first quarter reviews have left many blaming the negative effects of the strong dollar and predicting an ongoing negative impact on earnings in the USA.
Companies within the S&P 500 derive about 40% of their business from overseas trade. Reliant on international and global trading, approximately 20% of the companies are documenting their first-quarter earnings lower than previous years.
Computer giants HP are just one of the companies feeling the strain. Stating in their Reports Fiscal 2015 First Quarter Results that:
‘The US dollar has strengthened considerably since HP last provided an FY15 outlook … As is the case with many US based companies, this currency challenge is having a significant impact on HP's financial outlook.’
However it’s not just the large businesses feeling the pinch, as more and small businesses look to increase their sales through international trade, the rise of the strong dollar is proving problematic.
According to the Census Bureau (2013) approximately 98 percent of the estimated 304,000 American businesses with foreign custom were small and medium-sized businesses - and they accounted for 33.6 percent of all U.S. exports in 2013.
Most small and medium sized businesses have a fight on their hands – they simply don’t have the same options as larger corporations - they can’t just up and move to offshore to cheaper facilities, cut their prices and absorb larger margins.
This has led to a dramatic decrease in their orders as they lose out to cheaper competitors says Drew Nordlicht, managing director of HighTower Advisors for Inc.:
"Small businesses with an exporting focus will be negatively [affected] as the stronger dollar makes their products more expensive overseas, and they further suffer revenue losses as they convert their overseas unit sales back into dollars".
A group widely affected by this is the US online retailers who are trying to build up a global customer base - as the cost of international shipping will deter customers.
For Pennsylvania based Henry Moulded Products the exchange rate is an added pressure. They told Bloomberg ‘without the greenback’s run-up “we’d be hitting doubles and triples instead of singles.”
Another small business suffering is bike stand manufacturer The Upstanding Bicycle Company, as the stronger dollar creates a pricing problem. With distribution in Australia, Japan, Singapore, Thailand and Greece, 30% of their business comes from overseas trade.
The rise of the dollar has meant that the product has to be priced higher to compensate and benefit the distributor’s profit margins, in turn slowing growth and decreasing their customer base.
However, it isn’t all bad news. US focused small businesses who rely almost entirely on US custom could see good times ahead. Matt Phillips at Quartz states:
“The U.S. economy is heavily tilted towards consumption, and the strong dollar gives a purchasing-power boost to American wallets”.
The lower prices free up money for consumers to spend, putting disposable income back into their pockets - good news for many local retailers such as restaurants.
Baltimore based, Ellicott Dredges is just one of the more fortunate small businesses with growing global sales, multiple markets and an overseas manufacturing base in Europe.
The first quarter predictions have dominated the headlines, having an impact on businesses of all sizes.
An earnings recession hasn’t happened yet, but the downward trend is clear. However, some think that, despite the decrease in oil prices, the rise of the dollar and even the bad winter weather, the end results could actually end up looking far better than the initial projections.
Sam Stovall, stated in Forbes that ‘even though the forecast …is expected to decline…history shows that actual results have been…higher than initial estimates’.
‘As a result, there is still the possibility that EPS will rise, thereby delaying the start of an EPS recession.’
A glimmer of light for US based multinationals, perhaps, but for small business, the forecast is not quite so equivocal - the strong dollar is already spelling good news for native businesses who trade within US borders, but SMEs that rely heavily on international trade will struggle to keep afloat on these stormy seas.