Oil, dollar toll on earnings poised to rise

Oil, Dollar Hangover Casts Doubt on S&P 500 Earnings Estimates

• Profit risks also foreseen in interest rates, economic growth
• Deutsche Bank: `The worst of these drags should pass in 2015'

Falling oil prices and a strengthening dollar suggest earnings estimates for next year may be too high, according to David Bianco, chief U.S. equity strategist at Deutsche Bank AG.

The chart below shows the price of oil in New York trading and an index, compiled by the Federal Reserve, of the dollar’s value against seven other major currencies. Since last year’s third quarter, crude has dropped as much as $67.13 a barrel and the dollar index has climbed as much as 23 percent.

Every $5-a-barrel decline in oil reduces net income for Standard & Poor’s 500 Index companies by about $7.5 billion, or $1 a share, Bianco estimated in a Sept. 4 report. A 10 percent advance in the dollar’s value trims profit by about $20 billion, or $2.50.

Higher interest rates and slower economic growth may also hurt earnings, the New York-based strategist wrote. Each 0.25 percentage-point increase in the Federal Reserve’s key rate has the potential to reduce S&P 500 net income by 50 cents a share, the report said, adding that the global economy’s expansion may matter more for companies in the index than U.S. growth.

Bianco now expects S&P 500 earnings of $128 a share next year, up from $120 this year. For 2016, he wrote that $125 “is very possible” because of the effects of the dollar, oil and other influences even if U.S. gross domestic product, the value of goods and services produced within the country’s borders, rises 3 percent.

“The worst of these drags should pass in 2015,” the strategist wrote, adding that a valuation of 18 times earnings for the S&P 500 is justifiable because rates are low by historical standards. He reaffirmed that he sees the index reaching 2,300 next year, up from 2,150 this year. The latter prediction is below the median of 2,200 among 21 strategists as of Aug. 31 in a Bloomberg survey.

Oil's link to the dollar

(Bloomberg) -- Oil may be unable to conclude a six-month plunge as long as the dollar’s value keeps climbing, according to Burt White, LPL Financial Corp.’s chief investment officer.

As the chart shows, crude oil and the U.S. currency tend to move in opposite directions. The chart tracks the price of crude for immediate delivery in Cushing, Oklahoma, as compiled by Bloomberg, and a trade-weighted dollar index produced by the Federal Reserve. Oil is priced in dollars.

The correlation between oil and the dollar during the past 52 weeks was minus 0.99, about as negative as it could possibly be, according to data compiled by Bloomberg. Correlation can be between 1 and minus 1, with the latter showing one data series typically rises when the other falls, and vice versa.

“U.S. dollar strength may prolong the bottoming process for oil,” White wrote yesterday in a note. The spot price at Cushing dropped as much as 15 percent this year, bringing its tumble from a July 23 high to 58 percent.

The trade-weighted dollar index, by contrast, ended last week at its highest level since March 2009. The indicator is based on the dollar’s value against the euro, the yen and 24 other currencies.

Lower prices for oil and other commodities as the dollar rises may restrain inflation and affect Federal Reserve policy as well, wrote White, who is based in Boston. The central bank has left its key interest rate near zero since December 2008.