While the market declined modestly on the week, the outlook continues to be positive. Earnings were generally favorable, with Apple (AAPL), Visa (V), Amazon (AMZN) and Boeing (BA) delivering strong reports. Apple reported the largest single quarter profit of any public company in history. Additionally, Visa announced a 4-for-1 stock split after beating revenue and earnings estimates. Caterpillar (CAT) missed, but that was not surprising since the slowdown in China and tumbling resource prices have curbed demand for its products.
According to Factset Research, as of last Friday, 79 percent of companies have beaten their earnings estimates and more than half have beaten sales estimates. Earnings growth was only 0.25 percent though, hurt by lower energy prices. Aside from the energy hit, one theme in the market this week was the stronger U.S. dollar’s impact on multinational earnings. Several firms lowered guidance due to the impact of weaker foreign currencies. In most cases, these reductions were small and already factored into estimates for 2015, so the impact on stocks was muted.
We’ve been talking about the stronger U.S. dollar for months and positioned for it using funds that hedge currency exposure such as Vanguard Global Minimum Volatility (VMVFX) and WisdomTree Europe Hedged Equity (HEDJ). Although the euro did rebound against the U.S. dollar this week, the dollar bull rally continues in other currencies. The Singapore dollar tumbled and Denmark cut interest rates to negative 0.5 percent to defend its euro peg. Even more, the offshore Chinese yuan (traded in Hong Kong), Russian ruble, Mexican peso and Brazilian real all slid sharply versus the U.S. dollar.
While investors were focused on multinationals cutting their earnings estimates by a few pennies this week, attention will soon turn to the $9 trillion in U.S. dollar denominated debt held in non-dollar countries. Much of that debt has been borrowed by emerging market companies such as real estate developers in China. Ignoring any new borrowing, the value of this debt is rising sharply for overseas borrowers due to the U.S. dollar rally. In the past, this situation has led to banking crises, but much of this debt was borrowed from bond investors after 2008. In short, the U.S. dollar and interest rates on dollar debt could rise even faster in 2015 if these borrowers begin to default.
Moving beyond private debt, Greece is making waves in Europe as its new government demands to renegotiate the bailout, saying more loans won’t solve anything since the country can’t repay the existing debt. No matter what Europe decides to do, the situation will not be contained to Greece because it will set a precedent. If the Greeks get a better deal, Spanish voters will take note when they head to the polls later this year.
On Friday, the Bureau of Economic Analysis released the first estimate of fourth quarter GDP growth. It fell a little short of estimates, coming in at 2.6 percent versus estimates of around 3.2 percent, due in part to higher imports. Imports tend to rise when the dollar strengthens and this will likely be a headwind for headline GDP going forward. GDP growth for the full year in 2014 was 2.4 percent (based on this first estimate of Q4 growth), which is up from 2012 and 2013. The second estimate of 2014 Q4 GDP comes out in late February.