ARE YOU LONG ENOUGH USD EXPOSURE AT THE MICRO LEVEL?

Takeaway: On balance, equity investors should be increasing their exposure to US companies that have a large domestic footprint.

SUMMARY BULLETS:

 

  • We are buyers of US equities here provided that the US Dollar Index holds its intermediate-term TREND line of support and subsequently recaptures its immediate-term TRADE line of resistance. This, of course, assumes the broader equity market remains bullish TRADE and TREND in the process. For now, there is little fundamental reason to suspect that it won’t.
  • We ran a equity screen for publically-traded, domestically-domiciled corporations that break out their revenue by geographic segment. In the large cap bucket, our screen returned 270 names; in the small-to-mid cap bucket, our screen returned 1,684 names. The charts below show that, on balance, companies with a low degree of foreign currency exposure have been demonstrably outperforming those that have a high degree of foreign currency exposure.
  • All told, whether you’re a large-cap stock-picker or small-cap investor, you should be demonstrably increasing your exposure to US companies that have a large domestic footprint, on balance. Needless to say, continued underperformance awaits those funds whose managers fail to do so.
  • But don’t just take our word for it. Pull up the 2Q earnings releases from MCD, KMB or CAT. Those management teams will tell you all you need to know about our #StrongDollar call and its impact on various segments of the domestic equity market. Please email us if you’d like to dialogue with Howard Penney, Rory Green or Jay Van Sciver regarding their bearish theses on each of those three names, respectively.

 

FOLLOW THE BOUNCING BALL

We’ve often remarked that front-running inflections and/or sustained trends in the US dollar is integral to staying afloat in today’s increasingly policy-driven, globally-interconnected web of financial markets.

 

As the USD has appreciated in the YTD (up +4.1% on a trade-weighted basis), this rhetorically-simple, yet analytically-complex strategy has continued to work like a charm for us and our clients:

 

ARE YOU LONG ENOUGH USD EXPOSURE AT THE MICRO LEVEL? - 1

 

Moreover, it’s not enough to simply know what direction the US dollar is likely headed in; rather, the “why” is important as well. To recap:

 

  1. We think this latest USD rally has legs with respect to the intermediate-term TREND and long-term TAIL largely due to a positive resetting of structural growth expectations in the US, which itself is being driven by a reflexive recovery in the housing and labor markets, as well as accelerating household formation and birth trends.
  2. Additionally, we continue hold a demonstrably-bearish outlook for the JPY in the context of the BoJ’s monetary policy outlook and we also hold a structurally-subdued outlook for EUR appreciation in the context of the two-speed European economy.
  3. Lastly, we think the confluence of #StrongDollar and #RatesRising will create a reflexive feedback loop whereby global capital allocators continue to flow out of EM local currency exposure and back into USD exposure, at the margins.

 

As an aside, one of the ways we determine if the USD is appreciating because of rising growth expectations vs. international investors de-risking their portfolios is through cross-asset class regression analysis. In the event of the latter scenario, one would expect to see the USD hold positive correlations to various measures of financial market volatility and credit spreads, while registering inverse correlations to growth assets, such as equities.

 

That has certainly not been the case over the past year, which is consistent with our view that the USD is appreciating for growth reasons and not due to investor fear/economic uncertainty (TTM correlations to the DXY):

 

  • S&P 500: +0.75
  • Russell 2000: +0.70
  • CBOE SPX Volatility Index (VIX): -0.25
  • US Corporate BBB/Baa vs. US Treasury 10Y (bps Spread): -0.61

 

What is not consistent with our view, however, is the past three weeks of consensus anti-growth, anti-tapering speculation (trailing 3W correlations to the DXY):

 

  • S&P 500: -0.81
  • Russell 2000: -0.80
  • CBOE SPX Volatility Index (VIX): +0.59
  • US Corporate BBB/Baa vs. US Treasury 10Y (bps Spread): +0.80

 

We’ll continue to monitor these most recently developing price signals in real-time; for now, we hold the view that this is an immediate-term head-fake within the construct of an intermediate-term fundamental story. See the forest, not the trees…

 

HOW TO PLAY THIS

So what does this all mean for US equities? Simply put, we are buyers of US equities here provided that the US Dollar Index holds its intermediate-term TREND line of support and subsequently recaptures its immediate-term TRADE line of resistance.

 

ARE YOU LONG ENOUGH USD EXPOSURE AT THE MICRO LEVEL? - 2

 

This, of course, assumes the broader equity market remains bullish TRADE and TREND in the process. For now, there is little fundamental reason to suspect that it won’t.

 

ARE YOU LONG ENOUGH USD EXPOSURE AT THE MICRO LEVEL? - SPX

 

MACRO MEETS MICRO

For those of you who have been following our macro calls since the start of the year, you’ll quickly note that this strategy directive isn’t anything new. What is new, however, is the analysis below, which supports our view that equity market participants have been doing just that (i.e. taking up their gross exposure to the US dollar).

 

We ran a equity screen for publically-traded, domestically-domiciled corporations that break out their revenue by geographic segment. In the large cap bucket, our screen returned 270 names; in the small-to-mid cap bucket, our screen returned 1,684 names. The charts below show that, on balance, companies with a low degree of foreign currency exposure have been demonstrably outperforming those that have a high degree of foreign currency exposure.

 

ARE YOU LONG ENOUGH USD EXPOSURE AT THE MICRO LEVEL? - 4

 

ARE YOU LONG ENOUGH USD EXPOSURE AT THE MICRO LEVEL? - 5

 

ARE YOU LONG ENOUGH USD EXPOSURE AT THE MICRO LEVEL? - 6

 

ARE YOU LONG ENOUGH USD EXPOSURE AT THE MICRO LEVEL? - 7

 

(NOTE: The first two columns on each chart show the average performance of securities in excess of -1x and +1x standard deviations of the average percentage of revenues derived from the US for all companies less than 100%; the far right column captures the rest (i.e. those companies with 100% of their revenues sourced domestically). Per this calculation method, the average, -1x STDEV and +1x STDEV domestic revenue exposure for the large cap sample was 58.3%, 31.3% and 85.2%, respectively. For the small-to-mid cap sample, those figures were 61.9%, 36.6% and 87.2%, respectively.)

 

All told, whether you’re a large-cap stock-picker or small-cap investor, you should be demonstrably increasing your exposure to US companies that have a large domestic footprint, on balance. Needless to say, continued underperformance awaits those funds whose managers fail to do so.

 

But don’t just take our word for it. Pull up the 2Q earnings releases from MCD, KMB or CAT. Those management teams will tell you all you need to know about our #StrongDollar call and its impact on various segments of the domestic equity market. Please email us if you’d like to dialogue with Howard Penney, Rory Green or Jay Van Sciver regarding their bearish theses on each of those three names, respectively.

 

In a world were consistent alpha generation is increasingly hard to find the legal way, we continue to sing the praises of marrying top-down macro analysis with bottom-up fundamental analysis. Long live Wall St. 2.0!

 

Darius Dale

Senior Analyst


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