Clocks, scales, and meat slicers. IBM sold all kinds of different items when the company started out a century ago. Back then, it looked nothing like the information and consulting company it is today. It didn’t get into the business of personal computers until decades later. Today, IBM does everything but.
And yet, for all their commitment to changing with the times, their underlying business is imploding.
For years, IBM has resorted to aggressive accounting practices to hide the weakness in their business. They’ve taken on debt to buy back their stock, throwing cash to the wind that should’ve gone to developing their business.
And now that we’re in the middle of earnings season, there’s no other way to say it: results for big technology firms have been pretty awful.
Market leaders such as IBM and Apple have disappointed investors’ expectations out of the gate this year. The strong U.S. dollar is a major factor. With nearly 60% of sales for technology companies coming from overseas, the dollar has become a leading culprit in poor earnings.
Of course, this doesn’t surprise me. I’ve been harping on the strong dollar theme for quite some time. It’s also why our “old school tech” trade is our biggest short position yet in my research advisory, Forensic Investor.
And so far, it’s worked out nicely. But I think it has much farther to go.
Why is that?
For one, I think the U.S. dollar can get much stronger.
In fact, I think the dollar could rise by another 40% or more.
While the U.S. economy may be experiencing one of the slowest recoveries yet, it has very little to do with the value of a dollar. Like anything else, its value is based on supply and demand.
And being the world reserve currency, whenever there is a crisis in the market or even a minor scare, the demand for dollars goes up. People feel comfortable holding dollars in turbulent times. It’s a flight to safety. Or like sucking on a pacifier.
That’s one reason why the dollar remains in demand.
But, there is another more powerful reason.
When Everyone Runs for the Exit…
You see, throughout the financial systems there’s loads of leverage. Said another way: debt. And while investing using leverage tends to magnify returns, it also dramatically increases risk. Leverage works until it doesn’t.
And unfortunately, when it stops working, it often happens so fast that there’s little time to react.
This is a big problem because everyone runs for the exits at the same time during a panic. Large investment funds all have to start selling assets at the same time. And because they’re on leverage, it only increases the size of the losses and amps up volatility in the market.
That’s why, every time there’s a crisis, you’ll often read about large funds going out of business.
In recent years, funds have shorted the U.S. dollar to increase their leverage. Because interest rates have been essentially zero for a long time, investment funds could short U.S. dollars very cheaply. They could then reinvest that cash into higher yielding assets such as, say, emerging market debt.
The thing is, short sales need to be bought back and “covered.” This creates huge buying power for any asset in a short squeeze, especially if lots of leverage has been used.
In the case of the U.S. dollar, trillions in leverage has been used. So those dollars will have to be bought back in a crisis – and just like that, it will cause the value of the dollar to soar.
The Strong Dollar’s Here to Stay
It sounds strange that the economy could collapse and the demand for the currency could rise. But, that’s the benefit of being the reserve currency.
The knockoff effect is that this will only further hurt companies with a significant portion of international sales. Worse, they’ll get pinched on multiple fronts.
In the middle of a crisis, customers will start to pull back and slow down their purchases. So, revenue will start to slow – and in some cases, slow dramatically.
Adding to the pain, as the dollar rises, it will hurt earnings even more. And because companies have cut costs to the bone already, there won’t be many more places to generate earnings growth.
It’s a bit ironic. These companies have already manipulated their quarterly earnings results when the economy was rising. So when it falls, there won’t be any more tricks in the bag when they need them most. They’ll have run out of bullets.
All of this leads to a much tougher road to hoe for technology companies in particular, since they often generate more than half of their revenue overseas.
Growth was already slowing before the dollar started to eat into a big chunk of earnings. Early last year I often heard this this was just temporary. But not only is it here to stay, it will get much worse.
Tread very lightly when investing in technology this year.
John Del Vecchio
Editor, Forensic Investor