As earnings are released and currencies are significantly fluctuating because of concerns about inflation, it's likely that there will be impact on corporate earnings because of the change in relative currency values. Expect these headlines in the future.
The euro has been plunging and that will be a negative impact for global multinational firms that repatriate funds from Europe back to the United States. This means you may see companies experiencing earnings misses that have nothing to do with a recession or their business successes and everything to do with simply a change in the value of currencies.
Unsophisticated investors think that if a company misses earnings, it automatically means that there's a problem with the company's business prospects; that may or may not be the case. We look below the surface and read earnings reports to see what impact currency fluctuation has on corporate earnings and we believe this is prudent.
The highlighted article below provides a description of how currency can impact earnings. It's an excellent basic primer on how currency affects company profit.
On another note, I recognize that the last two months have been a challenge due to the correction in both the stock and the bond markets. I believe this is temporary but it will take time for a recovery to emerge. I will have more information for you next week on how recessions in general impact corporate earnings and markets.
If you did not attend our recent video update the link is provided here. It will provide you some insight on how we think about the market on an overall basis as well as the prospects for the economy on the short and intermediate term.
"What Are Foreign Currency Effects?
Foreign currency effects are gains or losses on foreign investments due to changes in the relative value of assets denominated in a foreign currency. A rising domestic currency means foreign investments will have lower returns when converted back to the local currency. On the other hand, a declining home country currency will increase the domestic currency returns of foreign investments. Various strategies exist to deal with or reduce this type of currency risk.
- Foreign currency effects are changes in the value of foreign assets or holdings due to currency exchange rate changes, which can result in either gains or losses.
- Currency-hedged ETFs allow retail investors to take positions in foreign stocks and bonds without having to worry about foreign currency effects.
- Businesses can use derivatives or forex markets to hedge their currency risk.
Understanding Foreign Currency Effects
Foreign investments are complicated by currency fluctuations and conversions between countries. A high-quality investment in another nation may lose money because that country's currency declined. Foreign-denominated debt used to purchase domestic assets has also led to bankruptcies in many emerging market economies.
Movements in currencies can have a substantial impact on the returns from foreign investments. Investing in securities that are denominated in an appreciating currency can boost total returns. However, investing in securities denominated in a depreciating currency can reduce profits.
Commodity markets are also impacted by foreign currency effects, especially the strength of the U.S. dollar. Most commodities are priced in U.S. dollars, so they may see significantly decreased global demand when that currency is strong. This lower demand can directly impact earnings for commodity producers.
When investing in foreign securities, returns are impacted by the performance of both the primary investment and the foreign currency. Some investors seek opportunities to align the foreign currency effect with bull markets in stocks. Others, who have less knowledge of currency markets or lower risk tolerance, attempt to reduce the foreign price effect."
Note: The above quote is intended for educational purposes only and does not constitute a recommendation to buy or sell any security or modify any current investment strategy.