How Much Hedging Do Companies Employ?
Given the large amount of discussion on how the U.S. dollar impacts earnings, we asked Bianco how much hedging he sees corporations employing.
His evaluation shows that companies tend to run hedges that are not much longer than their accounts receivables. Considering his estimate that 25% of S&P 500 profits come in the form of foreign currency, and that earnings number has not been hit nearly as badly, there is some degree of currency hedging going on. They key for Bianco, though, is that the hedges need to be rolled over and that ongoing earnings are likely to take a hit. This presents an opportunity for companies to raise prices, but they have been hesitant to do so thus far.
This is an important point regarding the competitiveness of companies. Companies like BMW in Europe may have placed hedges on their U.S. dollar revenue exposure and do not see the full benefit from a weaker euro immediately. But once those hedges roll over, those companies become much more competitive and see future earnings support at the lower exchange rate—just as Bianco believes these U.S. companies see further headwinds to earnings with the stronger U.S. dollar—even if they employed hedges that protected earnings this year.
Margins Continue at 10%; Multiples May Rise
Despite the headwinds to profits, net margins are still hovering around 10%. Bianco believes these margin levels are sustainable. The S&P is trading at multiples closer to 18 to 18.5x trailing price-to-earnings (P/E) ratio on the Index level. Bianco believes that a multiple higher than 19 and 20 times is reasonable for many sectors other than Financials and Energy. He believes there is P/E upside if long-term interest rates stay lower for longer. He foresees the 10-Year Treasury yield trading back to 3% to 3.5% by the end of 2017 and is increasingly leaning in to the idea that if long-term real interest rates stay below 1% to 1.5%, a 20 multiple is likely. As a result, he is over-weight Health Care and Technology, since they have the best sales and earnings growth by far.
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Unless otherwise stated, data source is Deutsche Bank Research.
These comments represent the general investment analysis and economic views of David Bianco and are provided solely for informational purposes. These comments do not relate to any specific fund or portfolio.