It’s all about the buck

The financial media has been focusing on (obsessing about?) the relative strength of the US  dollar of late, attributing much of the volatility we saw over the past week to the trader’s trying to guess which way, and to what extent, the big buck will be affecting the markets.

It’s kind of surprising that this talk about the dollar has just now grabbed the headlines. If you check the charts, you can see the dollar has been generally trending higher since 2012. The oil price drop helped speed its rise, with the buck now having appreciated over 20% since last summer to the point where it hit a 12 year high v. the euro last week. CitiFX reported that the dollar’s rally over these past eight months has been its fastest in at least 40 years.

The dollar, or any currency, gets stronger as the country raises its interest rates. The Fed meeting this week is thought to be giving us a better feel for when we will actually see rates go higher. US rates have already moved up in the market to reflect the fact that, timing notwithstanding, a raise is coming. With the Fed now being done with its easing plan and both Europe and Japan just starting theirs, it’s not really a surprise the dollar continues to go up as our rates are, and will likely continue to be, higher than most of the developed markets.

Why the goofy market last week?

First, there’s the oil price. The market is still trying to find a level for the price and the uncertainty about the timing and actual amount has earnings under pressure at the energy-related companies, as well as the banks and oilfield service companies that support them. No solution seems forthcoming for now.

Relative to the dollar, the big worry is regarding the big US multi-national firms. Over the past few years, they’ve had the wind at their backs as the, then, weaker dollar made our stuff cheaper in foreign markets. This has changed and, with just under half their sales coming from overseas, those firms will likely see earnings comparisons drop. This would lead to lower share prices.

Uncertainty, always the market’s biggest concern, is in full view here as well. According to BankAmerica Merrill Lynch, (BAML), interest rates around the world have been cut 558 times since fall, 2008. As a result, even small, steady interest rate hikes by the Fed is going to be a huge shift in how things have been done for the last six plus years.

When the global markets expect that our interest rates will be rising, it typically adds to the strength of the dollar. That’s because people rush to change other currencies into dollars simply because they can earn a higher return in dollar-denominated investments. The higher demand for the US currency also helps to drive its value up.

Downside considerations

Because most global commodities are denominated in (trade in) US dollars, the rising dollar helps to push down those prices. Gold, for instance, settled right at its lows of the year on Friday. Oil prices, aided by the continued low demand growth, are also pushed down by the big buck. The multi-national firms are the ones most affected by the drop.

Here’s a good quote from Mark Fields, chief executive of Ford Motor, on that. He said, “On the positive side, a strong US dollar indicates strength in our economy, and obviously, that’s good, given our position in the market here.” And then he added, “Alternatively, a strong dollar has an effect on our competitive position, especially against competitors who import here into the US.”
So, if your company is a major exporter, the dollar’s move is not the best of news.  Simply put, when the dollar is strong, it’s cheaper for Americans to buy foreign goods and more expensive for foreigners to buy things from us.

What about the benefits?

To reiterate, as a result of the strong dollar, every import that American companies use for their products is way cheaper, making them more competitive. And, for a service-based economy like ours, a major consideration is that the buying power of consumers is significantly improved as prices for energy, food, and virtually all goods and services have dropped.

Even better, the oil price drop, together with the strong dollar, is a stealth wage increase for consumers and acts like a double tax cut across the economy. That’s a pretty good duet, I believe.
Brian Belski, chief investment strategist at BMO Capital Markets has heard enough from the “dollar doomsayers,” particularly those who say the strong dollar will definitely derail the bull market. They’re increasing the “noise quotient,” he said. He wrote last week that, “This remains the largest stealth bull market of our collective careers, one that no one believes and everyone is OBSESSED with looking over their shoulder to diagnose its end. Strengthening US dollar means that the US economy is improving, which is a reflection of an increasingly stable and fundamentally sound US stock market -PERIOD… Changes in year-over-year earnings growth and the US dollar also have almost no correlation with each other historically.”

Personally, I support his view.

By the way, a long road trip may also be a dividend of the dollar’s rise. According to travel Web site TripAdvisor, hotel room prices would decline by 7 percent overseas this year, with a 9 percent fall in Europe. Air tickets trade in dollars, so no luck there.

Investing effect(s)

Compared with the rest of the globe, our economy is growing at a fairly healthy pace. That’s attracting more investment here. At the same time, the low oil prices have improved our trade balance. Those factors all contribute to a stronger dollar, which is rising not only against the euro, but also the British pound, the Japanese yen, and almost every other currency in the world. As the dollar’s value goes up, it attracts more investment, and spirals ever higher.

Additionally, rising interest rates, together with the strong dollar, is generally not good for the prices of commodities, bonds and bond equivalents like utilities. As they rise, the prices of those goods – and, likely, the shares of the companies which make them – tend to move lower.

Don’t get too concerned about the effect of rising rates on stocks just yet. According to economist Brian Wesbury, nominal GDP, (real GDP growth plus inflation) has been expanding near a 4.0% annual rate for the past few years, which is easily good enough to justify higher short-term interest rates. He believes, as do I, that short-term rates would have to rise to 3.5% or higher before concern of rotating away from stocks is warranted.

I want to be clear that we’re not at the point where the dollar is a problem. We’re currently in a time where all the trends are supporting the rising dollar. Americans are plenty happy to buy cheap foreign stuff. Plus, our economy and labor market are growing again.

Once again, don’t let daily volatility and/or headlines cause you to abandon your long-term strategy.

Cheers!

Mike

Securities and Investment Advisory Services offered through KMS Financial Services, Inc.

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