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Dollar Translation Effects Are Significant, but Not New News

Jeff Bagley
4/9/2009 12:38 PM EDT

From a corporate fundamental perspective, I always think about the effects of foreign exchange in two different ways: (1) the real economic effects that stem from changes in the relative competitiveness of U.S. products (i.e., a weak dollar makes U.S. goods more attractive for foreign purchasers), and (2) the accounting translation effects.

The second point is probably the most problematic with the dollar's resurgence in recent months, as U.S. corporations have been hit with a double whammy: falling real demand for products as economic activity has fallen off a cliff, plus the unfavorable translation effects from the stronger dollar. We've seen this on the part of many industrials lately, and also in a big way in the health care and consumer staples sectors.

What was a tailwind for a number of years has now turned into a headwind, and the effects are actually very significant. For example, orders might be down 17%-18% on a constant currency basis, but they are actually down 25% or so on a dollar basis. Given that the euro started to crack only in the latter half of last year, we will be dealing with very difficult year-over-year comparisons for the next couple of quarters at a minimum.

This is not new news, however, and one must believe that most analyst estimates already incorporate the resurgence of the dollar. Furthermore, the market is a forward-looking discounting mechanism, so if the dollar stays at or about this level, the profit comparisons start getting easier as we move into 2010.

"If" is the operative word here, so further dollar strength will probably be a negative on a fundamental basis, adding to the deleterious effects on the equities of various industries (energy, materials, etc.) that Howard Simons mentions in his post.

As far as the real effects are concerned, these have mattered less and less in recent years as the export sector has shrunk and as companies have naturally hedged by shifting operations overseas. By doing this, a good chunk of both revenue and cost is measured in foreign currency.

I will digress here, but I want to point out the added tax benefits from shifting operations overseas. Since a company pays U.S. tax on profits only when the money is transferred back to a U.S.-based subsidiary, the money rarely comes back to the U.S., and thus the tax can be deferred indefinitely.

This "loophole" is now being threatened by the current administration, however, and that is part of the reason why health care stocks in particular have underperformed. Adding 1,000 basis points to a pharmaceutical company's tax rate does not have a good result when plugged into a discounted cash flow model!

2. Likin' Wal-Mart Here

Brian Gilmartin
4/9/2009 10:58 AM EDT

We added to Wal-Mart ( WMT) this morning on the weak open, adding slowly to our existing position(s) now that "card check" seems dead, and the weaker numbers and guidance caused the stock to weaken at the open.

Little discussed with WMT has been the dollar strength, which in WMT's third quarter 2008 was expected to cost WMT 19 per share in fiscal 2010, (ends January 2010), however that has now been cut to 13 cents. Dollar comps don't get easier until after July, so as long as the dollar isn't smokin' strong, and has been in fact pretty stable to slightly weaker the past few months, WMT could benefit favorably at the edges.

Finally, because WMT started reducing capex (i.e., store growth) in late '07, free cash flow has really been robust. Our spreadsheet doesn't show any share repurchases last quarter, but they will be re-started eventually, because that excess cash has to go somewhere.

WMT has been in a 10-year bear market, since the late-1999, early-2000 high near $70. Earnings and revenue estimates are calling for just 4% EPS growth this fiscal year and 3% revenue growth, thanks to the dollar, so expectations are very subdued. Traffic has been good, and falling gas has helped margins. Free cash flow is growing rapidly. For a patient investor, WMT will be a market leader once again.

3. Retailers With Upside

Alan Farley
4/9/2009 10:08 AM EDT

Retailers reporting better-than-expected March same-store sales this morning:

4. Morning Trade

Bob Byrne
4/9/2009 9:27 AM EDT

So much for a relaxing holiday shortened week... Wells Fargo ( WFC) has ignited this market with their positive earnings announcement and Wal-Mart and Costco ( COST) are trying to bring us back to earth with their less-than-exciting sales numbers. The two levels we need to watch today are 848 and 823.50. Above 848, and the bulls have a shot a blowing the lid off this market ... below 823.50, and we are back in a chop-fest targeting 800.

The emini is trading just beneath our first resistance level at 843 ... if the bulls can hold the market above this area, they can make a run at 848. I expect 848 to be stiff resistance ... but given the bid under this market, it probably makes more sense to look for a few false breaks rather than an outright failure. Above 848, and the bulls have room to run to moderate resistance at 855.

With the emini fluttering around the 843 level, the bears need to make a stand and push back or risk being run over (again). If the bears are able to keep the emini under 843, they can target moderate support at 838 and 830. A break of 830 may turn a few heads, but it will take a move beneath moderate support at 825.50 and strong support at 823.50 to bring traders back to the short side.

5. WFC

Ken Wolff
4/9/2009 8:25 AM EDT

As CNBC has been reporting, we had a great headline on Wells Fargo ( WFC) guiding first-quarter EPS to 55 cents vs. 23 cents expected... A good way to play big news if you miss it is to look for a lagging trade as the headliner spikes. Bank of America ( BAC) was easily caught at $7.40 as WFC spiked.

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