Light it up with a Match! (DXY, PM, MO)

With the dollar rising as strongly as it has for as long as it has, there naturally arises a fear that corporate profits will soon feel the pinch.

And so it will be. Just as day follows night, overseas consumers will ultimately realize American products are becoming more expensive in their own currencies, and they’ll seek cheaper alternatives.

The process doesn’t happen overnight, of course, and corporations inevitably develop strategies to cope with these eventualities over the short term. But the end result of an unconstrained rise in the dollar is ultimately a crimp in corporate profits.

And that’s a big part of what’s scaring markets these days.

First, have a look at the buck –

dxy
This is two years worth of daily chartitude for the U.S. Dollar Index (DXY), and as you can see, the action has been full on bullish for the better part of five months. The rise (in red) of 10% against a basket of six of the world’s most powerful currencies has also pushed the dollar’s RSI indicator (at bottom, boxed) well into the grossly overbought several times over the last ten weeks.

Yet in spite of the fact that the buck appears to have taken a breather, many are still enumerating the potential damage a strong dollar might wreak.

Like Bloomberg News, which just recently worried out loud that we may be headed toward a ‘currency war’ of some sort in order to fend off an earnings disaster in the fourth quarter.

Could that happen?

 

Sure.

The Euro has been sliding – it’s down 8% in the last six months against the dollar and the trend looks like it’ll continue in the face of continuing weak German manufacturing numbers.

Unless a central bank or two intervene.

Surprise, surprise, though, it’s not America but Japan that may be the next country to step up to the devaluation plate. The BOJ is desperate to get that country’s inflation rate up to 2% in the next two years and most analysts are betting that at their next major policy meeting, due in just a couple of weeks, they’ll extend their current Quantitative Easing (QE) program.

Which doesn’t help America any.

Because the idea is to make the dollar weaker, to turn it…

98pound

So while a stronger dollar is certainly an indicator of economic strength vis-à-vis the rest of the world’s major economies, the Federal Reserve has already put the planet on notice that it’s not prepared to stand idly by while global growth slackens and America’s share of that growth also diminishes (due to dollar strength).

Our Challenge…

 

Our job at The Profit Hunter, of course, is to figure new and creative ways of profiting from the ever-changing investment landscape that’s presented to us. And today, we believe we have a play that accounts nicely for the current dollar strength and at the same time projects properly in which way markets are likely to trend in the event of more beggar-thy-neighbor monetary actions (i.e., money printing, or QE).

And it goes like this…

First, as we mentioned above, there are a great many American companies that are international in scope, whose overseas profits take a beating when the dollar gets too strong.

Conversely, local outfits that rely exclusively on domestic demand should see less of a hit on the bottom line, though their stocks could still suffer in a general market retreat.

And then there are companies that have taken the interesting step of breaking up their operations into separate domestic and foreign entities, with one company marketing exclusively to America while the other sells abroad.

smoke

One such outfit is global cigarette giant Philip Morris – or what was once referred to by that name.

Today Philip Morris is actually two separate companies, one called Altria (NYSE:MO), a corporate entity with a $91 billion market cap and a dividend yield of 4.52% whose stock is up 30% in the last twelve months. And the other is Philip Morris International, trading with a market cap of $131 billion and an annual yield of 4.76% whose stock is down 1% over the last year.

As the chart below shows, much of the discrepancy in growth between the two is the result of just the last three months trade – the same three months that witnessed a runaway rise on the dollar.

Look here –

MO
In blue, you see the dollar index (DXY), whose rise was also documented on our first chart, above. As the dollar has risen, so, too, has domestic cancer-purveyor, Altria.

PM, on the other hand has been roughly flat as the dollar rose – and not likely because folks overseas went on a health kick and stopped buying butts. Rather, PM’s revenues in U.S. Dollars were depressed by the relative strength of those foreign currencies the cigs were purchased in.

dean

We’ve chosen cigarettes, by the way, because we look really cool when we smoke demand is almost entirely unaffected by economic conditions. Alcohol is the same. Take away a man’s job or otherwise raise the price of his cigs and he’ll invariably find the cash to buy a bottle and a pack of smokes.

And that’s what gives our trade a certain predictability – unlike items from the consumer discretionary market, where it’s hard to know when or whether an item will simply disappear from consumers’ radar when economic conditions are altered, or indeed, when or if ever they’ll reappear.

The Tobacco Trade

 

We’re going to follow in the footsteps of William Penn today and the rest of the great American tobacco pioneers and set up a trade using the two aforementioned cigarette behemoths.

It goes like this –

We’re betting on the following scenario.

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That the Fed’s interest in a weaker dollar will very shortly be made manifest, pushing the dollar lower and bringing prices between Altria and Philip Morris International back into line with one another.

The Profit Hunter therefore recommends you consider purchasing the PM January 87.50 CALLs for $1.18 and selling the MO January 47 CALLs for $1.05. Total debit on the trade is $0.13 per pair traded.

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That the Fed’s interest in a weaker dollar will very shortly be made manifest, pushing the dollar lower and bringing prices between Altria and Philip Morris International back into line with one another.

The Profit Hunter therefore recommends you consider purchasing the PM January 87.50 CALLs for $1.18 and selling the MO January 47 CALLs for $1.05. Total debit on the trade is $0.13 per pair traded.

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With love of the hunt,

Hugh L. O’Haynew, Senior Analyst, The Profit Hunter

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