With earnings season midway through, the predominant theme is that U.S.-based multinationals are having a hard time compensating for strength in the U.S. dollar vs. currencies of foreign trade partners, despite strong top-line growth. In other words, business is improving for our blue chips, but it's coming at a pretty big cost -- either in the way of converting overseas revenue back to the strengthening greenback, or having to account for hedging strategies that are only getting more expensive as the dollar appreciates.
We have pointed to the potential for this phenomenon for a little while, and we have recommended investors consider lightening up on their U.S. large-cap exposure in preparation. For domestic exposure, it has been our contention that small-caps ought to hold up better in the near term, as a smaller portion of their revenue comes from outside the U.S. In addition to a more muted response to strong dollar headwinds, small-caps are also in a better position to take advantage of the tailwind offered by lower input costs. Along with the benefits of lower oil prices, the strong dollar allows these companies enormous flexibility with their overseas purchasing.
Is there anyone else for whom the strong dollar serves as a benefit, or at least not a major drawback? How about a sector in which there is no currency risk? A sector just about no one wants to touch right now? Of course, I'm talking about today's most hated group: energy stocks.
Companies that deal in oil are certainly worried about price fluctuations of the commodity and its implications for their most recent quarter's profit and future investment budgets, and these are the items at the forefront of investors' minds right now. These are nothing to ignore given oil's unabated plunge since August, but currency risk is one thing that won't be working against energy stocks.
Are the most pessimistic of expectations already being priced into stocks like Anadarko Petroleum (APC), Chevron (CVX), ConocoPhillips (COP), Continental Resources (CLR), Energy Transfer Equity (ETE), Exxon Mobil (XOM) and Kinder Morgan (KMI)? We saw Exxon dramatically cut its 2015 forecasts for both earnings and share buybacks today. The market expected this and the stock is up, probably on the belief that its forward guidance is now overly dire.
Conversely, a primary beneficiary of cheaper oil, the airlines -- American Airlines (AAL), Delta (DAL), Southwest (LUV) and United Continental (UAL) -- are getting crushed as oil advances solidly for the second straight day.
It's Not About the Price; It's About the Direction the Price Is Moving
As oil first started coming down last year, the discussion was about how there were influencing factors to the decline, but it was simply in the process of finding its natural price, without OPEC production cuts. There was talk of $80 oil, then $65 oil and $50 oil, and on and on. Only when oil broke $50 to the downside did we start hearing about $30 oil. I'm not sure where these folks were six months ago, but it seems a little silly to suggest oil will stop going down, and then settle for an extended period of time, at prices that are inequitable for just about everyone selling it.
Oil won't go down forever, and while it may be a while before we see $100 per barrel again, it's being underestimated how quickly it could jump off the bottom, wherever that is (or was). Any positive momentum is likely to attract two different types of buyers: hedge funds and institutions finally covering shorts, and those looking to lock in prices for consumption before they move too much higher (think airlines, chemical and industrial companies, and net importing economies like Europe and Asia).
Lower Oil Gives Our Foreign Competition Permission to Devalue Their Currencies
Should oil move meaningfully higher from here, it will put a good deal of pressure on companies and consumers of net importing nations whose currencies are weakening against the dollar, too. I believe the drop in oil has actually kept hidden a major problem for the currency debasers around the world.
If your currency is losing value against the USD, your incentive is to sell things to dollar users and buy less of what they produce (because you have to). But what if you don't have a choice?
Oil and gas consumption are measured in millions of barrels per day -- a rather large metric. And we already know oil and gas are denominated in U.S. dollars. If I'm continuously devaluing my currency against the dollar, it costs me more and more to fulfill my nation's energy needs. Unless, of course, the price of oil is falling even faster than my currency in relative terms.
What Happens When Oil Is No Longer Falling?
The benefits of depreciating one's currency against the USD will soon fade, as foreign nations' consumers and corporations who are net importers of oil and gas will feel the pain. My guess is this will finally put some downward pressure on the greenback, and possibly even further facilitate the bottoming in oil prices.
Higher oil is actually a good thing for the U.S. as a nation, and not just for our oil and gas industry.