Currency Headwinds Won't Stop These Stalwarts

Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Part of the difficulty with analyzing equities is assessing the international strength of the economy. A strengthening dollar and falling emerging market GDP growth will have a negative impact on multinational companies.

Global economic backdrop

Source: Ycharts

The iShares FTSE China ETF declined 22.61% year-to-date, iShares MSCI Brazil Capped ETF fell by 14.04% year-to-date, and the iShares MSCI Spain Capped Index Fund depreciated by 5.78% year-to-date.

Brazil is being hit by high rates of inflation with low rates of economic growth. Typical monetary easing tools cannot be used in Brazil; monetary easing would only increase the rate of inflation. This is why Brazilian stock values are falling, and the Brazilian central bank isn’t out purchasing assets due to inflationary risk.

China is facing its own sets of issues. The economy is transitioning into a service based economy. As a result, China is focusing less of its attention on exports. Processing trade inflates the total economic output without having any real impact on the economy. Reducing exports and focusing on consumption will cause falling rates of GDP. The Chinese economy may get a boost if the People’s Bank of China were to initiate accommodative monetary policy. Many outward looking forecasts assume a drop in GDP in 2013, with a recovery in 2014. Hopefully the Chinese government initiates monetary easing and offsets the decline in GDP.

Spain is in the middle of the pack. Austerity measures have pushed Europe into a double dip recession. It’s very likely that accommodative monetary policy (asset purchases and low interest rates) will persist for the rest of the decade. Fiscal stimulus is almost a no-brainer at this point, but Germany’s fear of hyper-inflation has made it difficult for the European economic block to initiate fiscal stimulus policies.

Buy U.S. equities

In the face of global uncertainty investors have invested heavily into U.S. equities. The greatest advantage of owning U.S. equities is the international exposure multinational companies have. It’s an indirect play on the global economy, and the stable growth in the United States GDP helps to keep a floor underneath U.S. equities.

Based on the economic challenges that Europe, China, and Brazil are currently facing, it can be assumed that a diversified play like owning the SPDR S&P 500 (NYSEMKT: SPY) could be the most lucrative choice for investors who want a reasonable mix of return and risk. The SPDR S&P 500 has a distribution yield of 2.08% and has a market capitalization of 149.3 billion. An overwhelming number of investors have opted to own U.S. equity index funds as a practical hedge against global economic uncertainty.

The currency backdrop

The recent bond market sell-off triggered a rally in the value of the dollar. The dollar for a moment at least, was considered the hedge against both bond and stock market volatility. However, the bond market has not been able to recoup all of its losses while the major stock indices like the Dow Jones Industrial Average and Standard & Poor 500 have been able to recoup losses. The trend clearly indicates that stocks are the way to go.

Source: Ycharts

The dollar index has appreciated by 3.35% year-to-date. The eventual tapering of quantitative easing will cause the dollar to appreciate. The assumption is that because other currencies will be undergoing accommodative policies (Europe and China) the value of the dollar should be able to appreciate against a basket of currencies. Because of this I believe that currency related losses will persist for both Coca-Cola and Johnson & Johnson.

Coca-Cola earnings highlights

Coca-Cola (NYSE: KO) has had difficulty with investors today. Not only have top line revenues declined, the bottom line net income has declined as well. The issue Coca Cola faces can be summarized by European austerity putting a ceiling economic recovery and the Asia Pacific experiencing headwinds from China. The dollar appreciation was the added nail in the coffin.

Coca-Cola estimates that the currency headwinds caused a 6% decline in revenues, which directly translates into earnings deterioration. The company was able to offset some of this decline with price increases on its beverages paired with improvements in case volume.

Total operating revenue declined by 2% year-over-year. The company cut back on operating costs by 1% year-over-year. The company could not off-set the lost revenue with operating cost cuts. Because of this, the lost revenue resulted in an 8% year-over-year decline in net income.

Johnson & Johnson earnings highlights

It turns out that Johnson & Johnson (NYSE: JNJ) had a fairly strong quarter. This was mostly driven by the strength in its pharmaceutical segment (12.9% year-over-year growth) and its med devices & diagnostic segment (12% year-over-year growth).

The growth in the two segments contributed to Johnson & Johnson’s consolidated 8.5% year-over-year revenue growth. The company reported a 17.7% year-over-year improvement in net earnings. The substantial improvement in earnings was due to costs increasing at a slowing rate while revenues improved at a faster rate.

Johnson & Johnson should be able to sustain reasonable rates of growth so as long as it manages costs effectively and continues to develop and market new pharmaceutical drugs. The company pays a 2.92% dividend yield and is trading at a 24.6 earnings multiple.

The multiple is fairly high, but the company’s dividend, earnings growth, and competitive moat (patents) help to justify the rich valuation.

Conclusion

I believe the currency effects will continue to have an impact on the earnings of multinational companies going forward. The effects should be temporary, and will eventually be offset by emerging market growth, price hikes on products and services, along with better management of expenses.

Johnson & Johnson may have more growth potential than Coca-Cola over the short-term. Longer-term both companies should be able to generate stable returns.

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Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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