Last week marked the beginning of earnings season, as corporations release the results from the first quarter of 2009. The season got off to a strong start with financial heayweights Goldman Sachs and Wells Fargo both smashing analysts’ expectations with large profits. Over the next few weeks, most listed companies will report earnings, which could collectively set the pace for financial markets for the next couple months. “Markets will continue to watch the corporate earnings data very closely in the short term with company comments on prospects also very important for sentiment with any optimism liable to curb defensive dollar demand.”

The last few weeks have witnessed a general decline in risk aversion, as investors have selectively interpreted economic data to support the notion that the economy as bottomed out. Improvements in corporate earnings could reinforce this trend, especially if a majority of companies beat analysts’ expectations. In short, “Forecast-busting first quarter results from Goldman Sachs on Monday encouraged optimism that the worst may be over for financial firms, but investors stayed cautious given that there are many more results to concern.”

It will be interesting to see if and how the strong Dollar will affect corporate earnings. On the one hand,the expensive currency would be expected both to drive a decrease in exports as well as a decrease in earnings from companies that do significant business overseas, since such companies earnings appear relatively smaller in Dollar-terms when exchange rates are more favorable. On the other hand, the decrease in the US trade deficit (to a nine-year low), suggests that the strong Dollar is not exerting a negative impact. “Exports sprang back in February after six months of decline, increasing by 1.6 percent to 126.8 billion dollars and comprising mostly consumer goods, automotive vehicles, foods, feeds and beverages.”

Ironically, an improvement in corporate profitability would further drive risk-taking and would thus have the effect of weakening the Dollar. One would think that an improved economic outlook would strengthen the Dollar. In actuality, financial and psychological factors continue to predominate in financial markets, and investors are looking for an excuse to dump the Dollar in favor of higher-yielding alternatives.

Their is a danger in currency markets taking their cues from stocks, given that the bear-market rally that unfolded over the last month is one of the most dramatic in history. The herd mentality has caused investors to become complacent about risk and pile willy-nilly back into the markets. Writes one analyst, “The growing potential for economic disappointment due to further growth contraction as well as overly confident, economically myopic policy-makers leaves stocks set up for a major wave of selling.”