Strong Dollar To Impact Corporate Growth

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Includes: HDV, LMT, VYM
by: Disruptive Investor

Summary

A strong dollar is having an impact on corporate earnings and investments as indicated by the CEO survey.

It is unlikely that the Fed will increase rates until the dollar weakens meaningfully. I therefore expect rate hike to be pushed potentially to 2016.

High dividend stocks with strong free cash flows are a good investment as companies scale back on their investments and increase shareholder payout in a relatively difficult business environment.

When I last discussed the view of policymakers, I opined that a strong dollar is one of the major worries as it has a meaningful impact on economic growth. With a dollar remaining strong against the yen and euro, the policymakers are left with a difficult decision on the timing of interest rate hike. In my view, an interest rate hike can be ruled out until the dollar weakens significantly from current levels. The impact of strong dollar on corporate earnings is one of the key reasons for this view. This article discusses the key points from the Duke CFO Global Business Outlook Survey to conclude that US GDP growth is likely to remain muted as corporate growth (the dynamic sector of the economy) suffers due to strong dollar.

The link here provides the Duke CFO Global Business Outlook Survey results for the first quarter of 2015. The survey includes 547 US firms, which provide their expectation for growth over the next 12-months.

In terms of earnings growth, the survey results point to an expected earnings growth of 8.2% over the next 12-months, down from 9% in December 2014 and 11% in September 2014. The muted earnings growth expectation is primarily due to two factors -

First, the slowdown in euro zone and China has depressed the outlook coupled with a slowdown in the energy sector.

Second, a strong dollar has impacted the earnings growth outlook in March 2015 as compared to September 2014.

The second point is further confirmed by the same survey result -

The stronger US dollar has hurt exporters. One-out-of-four US firms with at least one-fourth of sales in foreign countries have curtailed capital expenditure in response.

I must add that the capital spending growth expectation has also declined from 7.6% in September 2014 to 5.2% in March 2015. Therefore, there is a clear impact of strong dollar on the corporate sector and an interest rate hike would take the dollar higher against yen and euro. The policymakers would therefore delay rate hike until the dollar weakens.

Another interesting point from the survey is that the corporate sector expects minimum negative impact of rate hike on business spending and hiring plans. The point that I am trying to make is that an interest rate hike is not an issue for the corporate sector, but a strong dollar is a worry. Unfortunately, there is a strong link between the dollar strength and potential rate hike and this will ensure that near-zero interest rates sustain for longer than expected.

While the point on strong dollar impact on growth is clear, another important point from the survey is the likely growth in dividends and share repurchase in the next 12 months. Dividends growth was likely to be 5.9% as of September 2014 and it has increased to 10.3% as of March 2015. Similarly, share repurchase likely growth has increased from 0.4% to 1.9%. This is an important point to mention as companies are likely to use excess cash for dividends and share repurchase instead of boosting their capital expenditure. Therefore, revenue and earnings growth is unlikely to be robust in the coming quarters.

In conclusion, I believe that an interest rate hike can be potentially pushed into 2016 if the dollar remains strong. Further, earnings growth is likely to be impacted along with capital investments. In my view, investors can consider some high dividends stocks in their portfolio as companies are likely to increase shareholder value creation through dividends and share repurchase. Lockheed Martin Corporation (NYSE:LMT) is a good stock with a dividend payout of $6 per share and a dividend yield of 3.2%. I also like the defense sector considering the escalating geopolitical tensions globally. In addition, investors can also consider exposure to the High Dividend Yield ETF (NYSEARCA:VYM) and the iShares High Dividend ETF (NYSEARCA:HDV).

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.