The Dollar Is Starting To Hurt Multinationals, And The Market's Response To The Fed Was Ominous

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Includes: GDX, GDXJ, IAI, SIL, UUP
by: Mercenary Trader

Summary

We have said repeatedly these past few months that outlier strength in the mighty US dollar could be a bull market killer.

In the corporate earnings season prior to this one, the dollar was a non-topic.

Now everyone from Microsoft to Dupont to Procter & Gamble to Tiffany’s has cited the strong USD in their weakened profit outlooks.

We have said repeatedly these past few months that outlier strength in the mighty US dollar could be a bull market killer. Runaway upside in the USD meant bad news for corporate profit outlooks… general "tightening cycle" conditions for ROW (rest of world)… heightened blow-up risks for emerging markets in general… and a general withdrawal from globally invested assets (as US investors pull in their horns). For those who don't see the damage a rampaging dollar can do, take the following observation (via NYSE floor man Rich Barry):

"Just 5 months ago a product selling for 1,000 US Dollars would have cost a European 745 Euros. Today that same item would cost them 900 Euros. That's a 21% price hike in just 5 months! Is it any wonder why there are slower sales for US Multinational corporations?"

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In the corporate earnings season prior to this one, the dollar was a non-topic. There was such a lack of commentary on the strong USD, in fact, that it was cited by news outlets as a bullish sign. Nope. The pain just came with a time lag. Now everyone from Microsoft (NASDAQ:MSFT) to DuPont (DD) to Procter & Gamble (NYSE:PG) to Tiffany's (NYSE:TIF) has cited the strong USD in their weakened profit outlooks. Even the mighty Apple (NASDAQ:AAPL), which just booked an all-time record-smashing quarterly profit of $18 billion, said the crazy strength of the greenback held them back somewhat.

One can wonder, how much of this is scapegoating? After all, corporate management loves to blame the weather when they can get away with it. There is plenty of incentive to find causes "outside management's control" when results come in below expectations. But even if many of these complaints are scapegoating - putting a blame-weight on the buck that isn't really deserved - is that somehow better news for the bull case? If it's not the US dollar suddenly causing large numbers of multinationals to whiff, then it's something else.

The underlying monster strength of the USD, by the way, is a great answer to the common question: "Why bother with fundamentals vs. just technicals?" Answer: Because you get greater visibility as to the staying power of major trends.

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Crude oil, meanwhile, continues to look like a reverse image of the dollar as supply overwhelms demand. Crude oil is another area where we have been super-strong advocates, from the very beginning, of not fighting the trend. In addition to Saudi Arabia having every motivation to put marginal cost producers out of business - for the sake of long-term livelihood - there has been a gusher of North American supply hitting markets, as beaten and battered shale producers keep pumping to help service debts. Cash flow is cash flow: The process of shutting down marginal production takes time, and thus markets are forced to deal with a near-term supply glut. As with the USD, crude oil is another area where fundamentals matter: Trying to bottom pick because a move looks "overdone" is a recipe for futility, and danger, when you don't know the drivers.

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The flipside of a crude oil supply glut is incredibly cheap gas, and prices at the pump approaching $2 per gallon in some areas of the USA. This low-cost fuel acts as a "consumer tax cut" of sorts, in the sense that less money is taken out via the regular ritual of filling up at the gas station. Bullish money managers have pounded the table for the positive effect low-cost oil has on the US economy in plenty of areas outside of the US shale boom. The $64 billion question, of course, is whether the broad consumer benefit of cheaper oil outweighs the shock of job loss and credit blow-up via carnage in the oil patch. Whether or not virtually "all" of the US jobs recovery can be attributed to shale, as some claim and others dispute, there was certainly a good chunk of activity attributed to once-hot regions that now feel colder than a Siberian meat locker.

As of this Wednesday afternoon writing, another Federal Reserve meeting has come and gone. The Fed elected to be "patient" this time around, ruling out rate hikes for the next two meetings but not for June. The market was not happy. June, when you think about it, is really not so far away. Jon Hilsenrath, the unofficial Fed mouthpiece by way of the Wall Street Journal, captures the growing uncertainty:

Whether June remains a possibility for a rate increase will depend on how the economy and financial markets behave in the weeks and months ahead. The Fed's policy statement acknowledged the complex cross-currents it confronts as it plots a course for later in the year…

In other words: If you think the Fed will play nice, don't get your hopes up. They may in fact take action if the US economy continues to post good numbers… and that could mean the end of the party for corporate buybacks, "reaching for yield," and a whole host of other end-of-cycle bull market behaviors that grew obnoxiously complacent near the end.

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Last week we said we would short SPXL if a key support level broke. It never did. We finally got our short on anyway, in the last hour of Wednesday's trading, after it become clear the market reaction to the latest Fed meeting was negative. An acclerating sell-off into the close is exactly what hopeful bulls did NOT want to see at this juncture. The stage is now set for a potential downside break from congestion, which could lead to a true +10% correction in US equity markets for the first time in years.

Another "uh oh" bellwether response to the Fed: The sharp drop in financials (NYSEARCA:XLF). We are short both the broad financials (NYSEARCA:FAS) and the banks and brokers specifically (NYSEARCA:IAI), having gotten both positions on prior to Fed day (Wednesday). The aggressive drop and close-on-the-lows outcome for XLF and IAI speaks to the potential for real carnage. As with the brutal response to Microsoft's mildly disappointing numbers, when investors react harshly to news that is not extremely bad on its face, that is a warning sign as to serious trouble lurking below the surface.

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What of precious metals stocks? Last week we observed the strange juxtaposition of bullish price action in both the dollar and gold, as such fueling begrudging long positions in GDX, GDXJ and SIL…

In a nutshell, we are still long precious metals stocks but we don't like 'em. We even added to the position, pyramiding it a bit, and we still don't like 'em. The move just feels based on the wrong reasons… driven by hope and rationalization more so than truly attractive fundamentals. It may indeed be fund flows from Europe and elsewhere powering precious metals stocks higher… but it could also be diehard gold fans who are convinced, and will remain convinced forever and ever, that at some point gold stocks will be a big win so buy, buy, buy. We say this, mind you, with long GDX, GDXJ, and SIL on the books.

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Our problem with gold stocks, again, goes back to that mean old USD. As of this writing, the euro, Australian dollar and Canuck buck are all selling off hard against the dollar yet again… showing that USD weakness prior to the FOMC was mainly just pre-Fed positioning (as we suspected, and said outright via morning commentary in the Live Feed).

We have enough respect for the concept of "knowing what we don't know" to stick with a position based on price confirmation, even if we don't entirely like the rationale. But there is a difference between a false trend that makes internal sense, and shows sign that it could run for a while, and a false trend that seems doomed to getting brutally whacked by reality yet again. "Gotcha!" The other problem with precious metals equities, in our view, is their extreme sensitivity to "risk off" conditions: The money managers long them tend to also be long other risk assets, leading to "dump 'em over the side" type action when the bear comes calling.

Disclosure: The author is short SPXL, FAS, IAI.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Long GDX, GDXJ, SIL - also long the US dollar vs a basket of currencies