Two recurrent words in fourth-quarter earnings releases have been “currency translation.” Currency translation is the conversion of revenues, expenses and earnings realized in a foreign currency into U.S. dollars for reporting purposes. Depending on exchange rates, currency translations can be either a positive or a negative.

Last quarter, the euro was a notable negative. The euro fell from than $1.263 per dollar to about $1.216 per dollar. As the quarter progressed, each dollar of sales realized in Europe was worth less and less when converted to the greenback.

What I haven’t seen discussed in the earnings reports I’ve read so far is the impact on competiveness. To the extent that a stronger dollar makes American products more expensive, products from domestic/continental companies become more attractive from a price standpoint in their respective countries or currency zones. Several U.S. companies are pointing to the weak economic environment in Europe as a headwind, but not a loss of market share. It may too early for the stronger dollar to have an impact on competitiveness and/or it may be difficult to separate the headwinds caused by the European Union’s sluggish economy from the loss of market share caused by the stronger dollar.

The types of companies to have reported so far also has an impact. Earnings season typically starts with the largest companies reporting first, followed by smaller companies and then the retailers operating on a February-January fiscal year instead of a January-December fiscal year. To the extent that the large- and mega-cap companies conduct a larger proportion of their business in Europe and other international localities than mid-cap or small-cap companies, their revenues and earnings will be impacted more by currency fluctuations. Business models differ, so this statement does not universally apply to every large or small company.

The impact of currency translations can be somewhat (but not completely) avoided by investing solely in U.S. companies with domestic, but not foreign, operations. By doing so, you increase your exposure to the health or weakness of the domestic economy. You also limit the number of investment candidates to choose from and potentially leave yourself with a portfolio that is less diversified than it would otherwise be.

You could, of course, take positions in the currency market as a hedge. There does exist a diversification argument for holding currency funds or international bond funds. What I would caution against is directly trading in the foreign exchange (“forex”) markets. There are sophisticated firms with professional traders and staffs of economists competing against you in a market that is open 24 hours a day. While technical analysis can be used to spot trends, the professional traders see the same chart patterns. In my opinion, the odds in the forex markets are simply stacked too high against you and me.

A stronger dollar will always be a paradox for U.S. investors. As the dollar strengthens, it hurts corporate profits. It also reduces the value of our foreign investments in dollar-denominated terms. On the other hand, it feels good from a patriotic standpoint. A stronger dollar makes foreign-made products cheaper for us to buy. It also allows us to buy more shares of foreign companies and foreign funds for the same amount of dollars spent. Plus, should the euro rebound from current levels, you would get the benefit of a more favorable currency conversion plus any appreciation in the value of the investments beyond what is directly related to currency fluctuations.

• Using Currencies to Diversify Your Portfolio – Axel Merk explains the rationale for having some exposure to international currencies and how to go about doing so.
  
• The Cash Flow Statement: Tracing the Sources and the Uses of Cash – This financial statement can provide insight into how exchange rate fluctuations are impacting a company’s cash flow.
  
• Do You Prefer Companies with Mostly Domestic or Significant International Operations? – Tell us on the AAII.com Discussion Boards.
  

More than 60 members of the S&P 500 will report earnings next week. Included in this group are Dow Jones industrial average components The Coca-Cola Co. (KO) on Tuesday and Cisco Systems (CSCO) on Wednesday.

The week’s first economic report of note will be the December Job Openings and Labor Turnover (JOLTS) Survey, released on Tuesday. Thursday will feature January retail sales and December business inventories. The preliminary February University of Michigan consumer sentiment survey and January import and export prices will be released on Friday.

The Treasury Department will auction $24 billion of three-year notes on Tuesday, $24 billion of 10-year notes on Wednesday, and $16 billion of 30-year bonds on Thursday.

Two Federal Reserve officials are scheduled to make public appearances. Richmond president Jeffrey Lacker will speak on Tuesday and Dallas president Richard Fisher will speak on Wednesday.

Pessimism among individual investors jumped, while optimism fell to levels not seen in about four months, according to the latest AAII Sentiment Survey. The moves reversed the changes recorded in last week’s survey results.

Bullish sentiment, expectations that stock prices will rise over the next six months, plunged 8.7 percentage points to 35.5%. Optimism was last lower on October 2, 2014 (35.4%). This is the second time in three weeks, but the just fourth time in the past 26 weeks, that optimism is below its historical average of 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, declined 1.4 percentage points to 32.1%. Even with the decline, neutral sentiment is above its historical average of 30.5% for the fifth consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, reversed last week’s drop and surged by 10.0 percentage points to 32.4%. This is the largest amount of pessimism recorded by our survey since October 16, 2014 (33.7%). It is also the second time in three weeks, but just the fifth time in the past six months, that bearish sentiment is above its historical average of 30.5%.

The 3.1 percentage-point difference between bullish and bearish sentiment is the narrowest spread since July 31, 2014 (0.0). The bull-bear spread was last negative on August 7, 2014 (-7.3), when pessimism exceeded optimism.

A combination of recent price volatility and fourth-quarter earnings reports have contributed to the recent swings in both bullish and bearish sentiment registered by our survey over the past few weeks. Keeping AAII members encouraged is the overall upward momentum of stock prices, falling energy prices, earnings growth and sustained economic expansion. Causing other members to be cautious or pessimistic are disappointing earnings or guidance from certain companies, geopolitical events, the impact of falling oil prices on energy stocks, a sense that prevailing valuations for stocks are too high, the pace of economic growth and worries that an even larger decline in stock prices could occur.

This week’s special question asked AAII members how the stronger dollar is influencing their sentiment toward companies with international operations. More than third of all respondents (36%) said it is having a negative impact. Several of these individual investors said the stronger dollar is creating a headwind for corporate earnings or is causing them to be more selective about which stocks they buy. About 29% said the stronger dollar isn’t having an effect. Some of these respondents said they do not invest in foreign companies or view the currency fluctuations as part of a normal, cyclical trend. Slightly more than 10% of respondents said the stronger dollar is having more of a company-specific than a broad market impact on their sentiment.

Here is a sampling of the responses:

• “It does not affect my thinking. This is just a cyclical change. Soon enough fortunes will be reversed.”
• “Makes me less likely to buy or add to [shares of companies with international operations].”
• “Guarded. Some are okay and some I would avoid.”
• “I try not to invest in international companies.”
• “Companies with international operations are going to take hit to profits. Their share price will go down as a result.”
• “No change. I have a longer-term view.”

Bullish: 35.5%, down 8.7 points
Neutral: 32.1%, down 1.4 points
Bearish: 32.4%, up 10.0 points


Bullish: 39.0%
Neutral: 30.5%
Bearish: 30.5%

Individual investors’ allocations to bonds and bond funds rose to their highest level in nearly two years, according to the January AAII Asset Allocation Survey. Equity allocations stayed within their recent range, while cash allocations increased slightly.

Stock and stock fund allocations declined 1.3 percentage points to 67.2%. The decrease reverses December’s increase in equity allocations and matches November’s levels. January 2015 was the 22nd consecutive month and the 24th out of the past 25 months with stock and stock fund allocations at or above their historical average of 60%.

Bond and bond fund allocations increased by 0.7 percentage points to 17.5%. This was the largest allocation to fixed-income since May 2013 (18.1%). The increase also kept bond and bond fund allocations at or above their historical average of 16% for the eighth consecutive month.

Cash allocations were 0.5 percentage points higher in January than in December, at 15.3%. The magnitude of the increase was not large enough to keep cash allocations from staying below their historical average of 24% for the 38th consecutive month.

The increase in fixed-income exposure was due to a larger allocation to bond funds. Among surveyed AAII members, the average allocation to bond funds was 14.4% last month, a 1.1 percentage-point increase over December and a 1.9 percentage-point increase over November. The current allocation to bond funds is the largest recorded by our survey since April 2013 (15.9%).

The downward trend in yields led to a good year for longer-term bond funds and may have made them more attractive to individual investors. A down month for stocks may have also played a role in shifting investment dollars out of equities, even though short-term sentiment among individual investors largely stayed above average throughout January. Even with this month’s allocation survey results, many AAII members continue to be frustrated by low bond yields and low interest rates on money market accounts.

Last month’s special question asked AAII members what, if any, allocation changes they expect to make this year. Slightly fewer than three out of 10 (30%) said they don’t anticipate making any changes. About 16% intend to increase their allocations to equities, while 7% plan on reducing their exposure to stocks. Close to 15% intend to boost their bond allocations and just under 10% say they will boost their cash allocations.

• Stocks and Stock Funds: 67.2%, down 1.3 percentage points
• Bonds and Bond Funds: 17.5%, up 0.7 percentage points
• Cash: 15.3%, up 0.5% percentage points

• Stocks: 31.0%, down 1.1 percentage points
• Stock Funds: 36.2%, down 0.1 percentage points
• Bonds: 3.1%, down 0.4 percentage points
• Bond Funds: 14.4%, up 1.1 percentage points

Take the Asset Allocation Survey.

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