A Day Late, And A Dollar….Short?

This article was originally published on on April 27th at 10:00am EDT

Have we all been wrong about the US Dollar’s role in oil weakness—and, in fact, has the influence been the other way around? Is oil actually the primary driver of how much a dollar is worth globally?

Two widely held beliefs regarding US dollar strength over the past eight months:

1. The culmination of our Quantitative Easing program, in conjunction with the commencement of QE in Europe and the enhancement of QE efforts in Japan meant invariable US dollar strength. Less dollars “being printed” relative to Euro and Yen should mean a stronger US currency, right?

Well, it’s not that simple of an argument—especially since the Fed was never actually printing money.

2. The strengthening USD played a large role—in addition to global oversupply—in the cratering of oil prices. After all, oil is priced in USD, so if each dollar is worth more than it was yesterday, then you don’t need as many of them to buy a barrel of oil (or anything else denominated in dollars).

But does the Fed have less to do with deciding our currency’s strength than global commodity markets do?

Take a look at this chart which reflects the value of the USD versus a basket of other major currencies (PowerShares Bullish US Dollar Index—UUP), overlaid against the price per barrel of West Texas Intermediate Crude Oil for the past eight years.

I see a clear correlation between bottoms in oil and tops in the USD, at least over the short term. What if we’ve been wrong about the USD’s role in the price of a barrel of oil? What if, in reality, it’s been the weakness in oil that has dictated where the dollar has gone?

But this article isn’t about oil…

Bottoms up.

It seems most professionals in the financial media are arguing for further dollar strength—after its rally of about 20% since mid-2014 the trend shall continue to be your friend, they say. And they could be right. But what if they’re not?

If oil has in fact bottomed, as we believe it did three months ago, isn’t it possible that US Dollar strength may be over for now? And if that is true, what should we be looking for?

US Large Caps have largely disappointed thus far in 2015 in terms of earnings and guidance, and almost without exception US Dollar strength has been to blame. A good example is IBM—a snip-it from their fourth quarter report and 2015 guidance appears below:

While its core software business posted 7% year over year decrease in revenue to $7.6 billion (down 3% in constant currency), Global Technology Services revenues declined by 8% year over year to $9.2 billion (2% growth in constant currency). Furthermore, its Global Business Services revenues declined by 8% to $4.3 billion (3% decline in constant currency), despite growth in new business initiatives (i.e. cloud, business analytics and big data). IBM’s system and technology division continued to disappoint and reported 39% year-over-year decline in revenues to $2.4 billion (down 12% in constant currency), primarily due to product transitions and market disruptions.

Every single business segment was hurt, enormously, by dollar strength—the term “constant currency” means hedging out currency fluctuations. It is my feeling that IBM’s current stock price, which is in the exact same place as it was four years ago, is reflecting the prospect of currency headwinds continuing in perpetuity. And the chart below shows some definitive correlation between dollar strength and downward pressure on IBM’s stock.

Another interesting trend can be seen when you overlay IBM’s stock price with its EBITDA per share. You’ll notice that the gap formed in 2009 by IBM’s stock correction (along with pretty much every other stock) was quickly reconciled. A similar gap exists today, and because of IBM’s diligence in reducing share count via buybacks, EBITDA per share ought to continue climbing.

Upside to IBM stock from here could be 20%, not including dividends—more importantly, though, is that downside may be limited due to rock bottom expectations and the removal of dollar strength as a headwind.

Now I’m not suggesting that the dollar is going to weaken dramatically from here, but should the strengthening have stopped or even reversed course a bit, we may have the ingredients for positive earnings surprises for the remainder of 2015. And the same argument that we’re applying to IBM shares may hold true for other large cap multinationals like Boeing (BA), General Electric (GE), American Express (AXP), and Coca-Cola (KO).

The picture has shifted a bit, and it’s a good time to take calculated risks in strong brands that have been beaten up by dollar strength.

If you have any questions or feel we may be able to help you with your portfolio, please don’t hesitate to give us a call.

Adam B. Scott
Argyle Capital Partners, LLC
10100 Santa Monica Blvd, #300
Los Angeles, CA 90067
(310) 772-2201 – Main

Adam Scott’s profile on RealMoney can be found here.

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