We are entering the belly of the beast in terms of December quarter earnings season, and it looks to take some wind of the stock market’s sail

The reason?

Even the more positive earnings reports that we’ve seen over the last few days still contain reasons to be cautious in the near-term. Consider our comments on Apple’s “record” (AAPL) yesterday where the bottom line beat relied on the company’s stock repurchase plan and warned the impact of foreign currency is likely to get worse in the current quarter. That’s just the latest in a series of such reports from the likes of United Parcel Service (UPS), MasterCard (MA), McCormick & Co. (MKC) and others that have hedged their bets on continued dollar strength

 

While it’s true the Fed didn’t boost interest rates coming out of yesterday’s Fed meeting, hardly a surprise given the recent December rate hike and the current environment in DC that is its own kit and caboodle of uncertainty, the January PMI and ISM data point to the likelihood that we could see a rate increase in the coming months.

 

Per Markit’s January Manufacturing PMI report, “January data revealed a renewed acceleration in output growth among manufacturing firms, with the rate of expansion reaching its strongest for 22 months… The US manufacturing sector has started 2017 with strong momentum. Despite exports being subdued by the strong dollar, order books are growing at the fastest pace for over two years on the back of improved domestic demand.

As you know, we are data people here at Tematica and one month of data is too little to call the start of a trend, but the January report builds on the upturn we saw in the December data. The fact that these reports are showing a pronounced pick up in order activity is not lost on as that metric tends to be a forward looking indicator.

 

Looking at the Fed’s Federal Open Market Committee (FOMC) calendar, the next meeting is slated for March 14-15. While that is just six or so weeks away, it allows the Fed to capture two more months of manufacturing and services data. Should that reported data exhibit similar strength to that in December and January, we could see the Fed begin to move on its voiced target of up to three interest rate hikes this year.

 

In our view, this would lead to a rebound in the dollar. Moreover, it’s likely to come at a time when Eurozone elections are starting to hit and yes, as we expected we are starting to hear more about Grexit and Brexit. Should that grow from the current chatter to even a mild roar, we are likely to see foreign investors head for ports of safety, and that likely means the dollar.The above combination could push the dollar back to December levels.

 

 

 

Most investors tend not to trade in currencies, and we don’t blame them, but given one of the advantages of the exchange traded fund (ETF) market is we can easily invest or trade in some of the more exotic strategies when appropriate. In this case, the long dollar strategy that we are adding to the Tematica Pro Select List is found in PowerShares DB US Dollar Index Bullish Fund (UUP), one of the more liquid ETFs to track the dollar. Unlike a number of the more exotic ETFs, UUP not only has options, but some of them are rather liquid as well.

 

That brings us to the PowerShares DB US Dollar Bullish ETF (UUP) June 2017 $27 calls (UUP170616C00027000) that closed last night at 0.23. Contract volume is healthy and the June time frame gives us ample room for our dollar thesis to play out.

• We’d be buyers of the PowerShares DB US Dollar Bullish ETF (UUP) June 2017 $27 calls (UUP170616C00027000) calls up to 0.32.
• We will set a stop loss at 0.10. Yes, that’s a wider than usual stop loss, but our view is we would rather build the position on weakness should forthcoming domestic economic data mimic the strength in this week’s PMI and ISM data.

 

As we close out this week, the view on 2017 earnings expectations for the S&P 500, our preferred benchmark for the stock market should start to firm up. As that happens we’ll continue to eye thematic opportunities for new option positions, but as we wait for that we’ll continue to keep the inverse ETF positions on the Select List active.