Tag Archives: us equity markets

Insidious Effects of the Dollar’s Decline

The United States is home to the largest and most liquid investment markets in the world. There’s hardly a market one can think of that isn’t exchange listed. This has made the United States the primary destination for excess global capital placement whether it has gone towards the relative safety of government bonds or been more aggressively allocated towards stocks, ETF’s or even the futures markets. The final destination of the investible funds is less important than the singular characteristic that all these investments have in common. They’re denominated in US Dollars and the Dollar’s value may be more meaningful than the underlying asset class.

Investment securities are not protected from the vagaries of their underlying currencies. Therefore, globally allocated investments owned in US Dollars can lose money in a flat market if the Dollar declines. The Dollar peaked in early July and has since fallen by more than 6%. Therefore, if your US equity portfolio hasn’t gained more than 6% since July, you’ve actually lost money. The Governmental shut down has accelerated the recent slide and pushed the Dollar to a new 30 day low for the second time this week. This is only the second time since May of 2011 that we’ve made multiple 30-day lows in the same trading week.

Perhaps more troubling to global investors than the currency-based loss is the fact that the traditional safe haven investments, even in Dollar terms, have not behaved as expected. The primary relationship between the Dollar and the US equity markets since the financial implosion of 2008 has been negative. This has been embodied by Dollar rallies on stock market declines. Very simply, foreign capital gets converted to US Dollars and placed to work through buying declines in the stock market. Conversely, when foreign investors take profits in a rising stock market and convert back to their base currency, the Dollar falls.

We also see this relationship play out in the gold market. Economists on TV tell us to buy gold as a defense against a declining US Dollar. Sensationalists point to the overwhelming debt being created by our country and tell us to buy gold because our country is on the verge of implosion and our currency will become worthless. Speaking of correlations, it’s amazing how many of the people saying this are the ones selling gold investments. Astute investors would notice that the correlation between these two markets has been trending upwards since early June. This means they’re moving in the same direction more frequently rather than opposite each other as expected.

Foreign purchases of US goods have always been Dollar dependent. Every nation and agricultural enterprise within every nation is forced to tie their commodity purchases accordingly. Therefore, it becomes especially disturbing when a weaker Dollar fails to attract foreign purchases of global staples. Beginning in August of 2012 we started to see the commodity markets decouple from the US Dollar. Wheat was the first market to be sated. Corn followed suit in October of 2012 and hogs joined the new normal last November. This means that even base foreign needs have been filled. Therefore, they are more likely to trade in the same direction as the Dollar going forward rather than the typical negative correlation that we’ve seen from bargain hunters looking for inflation in the commodity markets.

The International Monetary Fund (IMF) stated that world Consumer Price Index (CPI) came in at 3.2% year over year for August. This is down from 4.9% a little over a year ago and ties in rather neatly with gold’s last run at $1,800 per ounce early last October. The US unemployment rate is generally believed to be artificially low in the as reported number of 7.3% and Gross Domestic Product (GDP) here in the US came in at a very tame 2.5%. These statistics, combined with a low global industrial capacity usage number suggest that inflation is nowhere near. Furthermore, the Federal Reserve Board’s recent decision not to implement a tapering of the $85 billion per month in economic stimulus reinforces the notion that their primary concern is deflation, rather than inflation.

Many economists believe that we may be near a tipping point in the bull run that has followed the economic meltdown of 2008. The obvious concern now lies in the protection of the wealth that’s been garnered during the recent run. Clearly, the ownership of alternative investments isn’t going to play out the way the pundits have suggested. Therefore, investment vehicles that will profit from a decline in both asset value and currency depreciation should be seriously considered. These include inverse ETF’s as well the futures markets, which will allow the seamless execution of short trades including currencies. Equity futures spreads selling small caps like the Russell 2000 and buying big caps like the S&P500 are also a good idea when expecting volatile, downward markets. Remember that cash is only king as long as the King’s throne isn’t sinking.

Dollar’s Strength an Anomaly?

The U.S. Dollar surged through its daily resistance and is well on its way into the overhead weekly resistance between 75.88 and 77.24. Although the rally has been impressive, it’s important to maintain the perspective that the Dollar is in a bear market. Even if we were able to rally another 300 points, that would only bring us back to the 38% retracement level from the ’06 highs.

Of recent interest in the Dollar’s surge are the factors that television commentators claim are fueling it. The major factors receiving notice are, the decline in energy prices and commodities in general, the European Central Bank’s deflationary comments and finally, the worse than expected jobless claims number. The following factors are deflationary and the U.S. equity markets are rejoicing.

I would ask the question, “Have the preceding factors created a bottom in the economic cycle or, are we seeing a more general global slowdown?” I believe that the domestic economic issues have not been addressed and that a globally deflationary environment will create more problems for the U.S. Dollar than it will solve.

First, examine the chart on import prices. The double top may have proven to be the limit. Clearly, it has already begun to turn down. This index includes oil which, when priced separately, is 5% higher than imports in general. Oil is germaine to the topic because the $25+ decline has NOT been priced in and will contribute greatly to the establishment of this chart’s double top.

If, in fact, overall commodity prices are topping out then, this will also reduce demand for U.S. commodity exports. Exports have helped to offset the declining Dollar over the last two years as global demand and globally anomalous weather patterns have made the U.S. the supply center for the world. Dollar strength and, or a global slowdown will curb the primary growth engine for the U.S. economy. What effect will this have on a sluggish employment picture?

Obviously, the unemployment pressure is still to the upside. Will global commodity deflation offset the cost of a declining employment base? According to many pundits, the tax refund checks have gone to cover current expenses, rather than paying down debt. That leaves many people still looking for meaningful employment opportunities. This is most clearly illustrated in this week’s jobless claims.

The past two weeks’ claims have surpassed the historically significant 450,000 threshold. As you can see from the chart, this threshold is frequently accompanied by a recession. Based on the previous factors, I fail to see continued strength in the U.S. Dollar or, the U.S. economy. While the equity markets have broached the 20% bear market threshold and, recently bounced, I still view this as a selling opportunity in both equities and the Dollar.

It appears that this is beginning to be priced into the interest rate markets as well. Inflationary pressures are easing. This is taking the pressure off of the Federal Reserve Board to tighten rates at the next meeting on September 6th. Furthermore, the declining employment picture will add pressure to hold or, LOWER, rates at meetings through the end of the year. This stance is contrary to the hawkish inflationary stance that has been their premise for much of this year. Finally, the combination of a declining equity market in an election year would also add to the shift in the FOMC’s position from hawkish to dovish. The last chart is beginning to tip the market’s hand as it points to lower rates ahead……once again leading to a lower Dollar.