Stocks Struggle with Rising Dollar

In 1973, when inflation pressures forced the the US Government to abandon the Bretton Woods system of gold backed fixed currency pegs, the world embarked on a journey of ever escalating leverage. The Dollar initially devalued sharply along with stocks until higher interest rates created a base value. Bond yields then fell for the next 40 years to maintain leveraged economic growth in a disinflationary fiat currency world. Stocks were hyper sensitive to Dollar moves in the 1970’s, but in todays over supplied capacity era, equities have become less volatile relative to changing currency values. In general, a rising US Dollar is a headwind for the stock market and a falling Dollar is a consumption tailwind. The US Dollar typically falls towards the final innings of a Recession, allowing commodities to surge and resource based emerging market countries to export and recover. The worlds commodities are priced in Dollars and need a falling Dollar to inflate their value. The 2020 global Covid contraction has been no different. Once the markets realized that Central Banks and Global Fiscal policy would backstop the financial system and artificially inflate personal consumption, the Dollar fell precipitously from the end of March to the end of  December. This was generally a period of rising commodity prices and optimism amongst export dependent 3rd world countries. The commodity Bull was interrupted by the Warp Speed success of vaccine development in late 2020 and dominant US  rollout of vaccines to its population in early 2021 that boosted the US Dollar. Europe took the lead in the recovery optimism race in 2020 with lower viral impairment, but the US has rebounded more sharply in 2021 with a quicker than expected return to an open economy. 

As social mobility in the US edged higher this year, Europe and most of the world were simultaneously imposing the most restrictive conditions on their economy in months. The near US monopoly on vaccines, the widening rate of success in vaccinating our population vs other countries has boosted US economic activity and expectations more than the rest of the World. German 10 Year Government bonds are still yielding a “negative” 0.3% while the the US 10 Year is testing 1.75%. While yields will continue to rise everywhere, assuming viral cases keep falling, we suspect that Europe is within weeks of beginning to narrow the vaccination rate deficit with the US. When that occurs the Dollar will start to trend lower once again. Later this Summer the relatively better growth forecasts for Europe will spread to Emerging Markets and boost commodity prices. At that point 3rd world stock markets could take the lead in world equity performance. Thus US equity market dominance should peak in April and shift to Europe by Summer and then to emerging market stocks as the vaccine supplies finally reach critical mass to boost the global economy.

Almost 28 percentage points separate the US with Germany and all of European vaccination rates today. We expect this gap will peak in April. While better values can be found in European stocks as vaccination rates accelerate later in Q2, the good news for US growth investors is that the beleaguered tech stocks should begin to rebound then as well after recent months of underperformance. Capital intensive tech stocks like a falling Dollar along with stable to lower interest rates more than the value market sector. For now, the higher beta tech sector retains the most risky. Zeitgeist stock, Tesla has fallen 30% from its recent highs near 900, despite Ark guru Cathie Wood Buying more with a 3,000 target. If the Dollar and interest rates keep rising, Tesla and other Tech leaders would still have considerable downside risk in a broad market correction. Once the Dollar rolls over later in Q2 we would look for diversification value buys in Tech as well as the European and reopening sectors.

It’s easy to visualize the relationship of US stocks and the Dollar here. When the Dollar fell sharply and seeded a global rebound in 2020, the broad based stock market (SP 500) surged higher. As the Dollar surged in March, stocks struggled to make gains despite the $100’s of Billions in new monetary liquidity and fiscal handouts to individuals and small businesses.

This inverse correlation of stocks and the US Dollar is even more pronounced when comparing the Tech heavy Nasdaq. 

The good news for stocks, tech investors, European and emerging markets is that the Dollar appreciation should peak in the first half of 2021 and lead to a resumption of the commodity Bull market during the 2nd half of 2021 as the world economies begin to open up enough to allow a resumption of social mobility at a robust new normal. Some of the increasing travel will continue to remain by car and a portion of business travel will stay glued to their laptops. However, with Trillions of excess liquidity and a personal saving rate far above any recovery period in history, economic activity will expand faster than any period in decades, barring a surprising 4th wave of Covid. Europe entered a scary new 3rd wave of Covid in mid March, but the fears of a growing 4th wave in the US are hopefully exaggerated. With most of our vulnerable senior population already immune and vaccine availability to all adults in all states likely within days, it’s more probable that the current US viral uptick will be the most modest wave of Covid yet. The key technical metrics for investors will be the Dollar and interest rate yield momentum. When they are accelerating higher, as they have throughout March, stocks will struggle until a pain point is reached that triggers a deeper market correction. When the Dollar downtrend resumes later in Q2, the broader equity markets will be ready for a new acceleration to the upside. Medium term forecast Buy zone for stocks is due in the May – June time frame.


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