FX losses rocket after currency chaos – but a drift downstream is the biggest risk

Over the past two years, foreign exchange (FX) volatility has stepped up negative currency impacts, with affected Fortune 2000 companies reporting losses of $17.8 billion in 2013.

Research conducted by FIREapps focussed on the 846 Fortune 2000 companies that have at least 15% or more international revenues in two or more currencies. Last year, the Japanese Yen and Brazilian Real were cited as having the most impact, with the Australian and (surprisingly) Canadian dollar also causing trouble for treasurers. In the fourth quarter, for the first time, the Euro was not listed in the Top 5. Overall, however, emerging markets proved to be the primary culprits, affecting around 49% of companies surveyed in Q4.

According to the report, when international corporations decided two and a half years ago to pursue a strategy of double-digit growth in emerging markets, they greatly underestimated the currency risk that this would incur. Panic set in at the start of the year, when Argentina’s peso nosedived by 15% in a single day. This led to huge sell-offs of emerging market currencies as the contagion spread to markets such as Russia, South Africa and Turkey.

Whilst the investment flowed in and these emerging markets grew, volatility played into the hands – and wallets – of investors. But acceleration on the downside has now outstripped gains, leaving companies worse off as a result of their gamble.

In addition to the immediate financial damage, these shocks can have a lasting impact on a company’s share price. As the principles of loss aversion have shown, losses are felt more keenly than gains (around 2.5 times more keenly, in fact) and the truth of this is seen in the aftermath of nasty surprises like as FX losses. The phenomenon of post-earnings-announcement drift sees “abnormal” earnings trigger a delayed market response, sending stock prices slowly creeping up or down for an extended period after a “good news” or “bad news” announcement, seemingly carried along by its own inertia. Since most interpretations of this drift boil down to investor underreaction or overreaction to an initial announcement, it seems fair to imagine that those still reeling from the crash might be especially sensitive to potential loss over potential gain.

Recent patterns in post-earning-announcement drift have borne out this hypothesis, according to Anju Merempudi and Maureen Wolff. In a paper entitled The Guidance Effect: Improving Valuation, the researchers showed that amidst a “climate of fear and uncertainty” companies in the Standard & Poor 500 are seeing their stock drop, on average, by more than four times the number of basis points after bad news than they are seeing it climb after good news.

These fears can be assuaged, at least in part, by increasing transparency and providing guidance to contextualise results, says the report. But the overall message is clear: investors are jumpy, and nasty shocks can ripple through prices for months to come.


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