Don't Fall Prey to Dollar Doom. Markets Have Priced the Risk
The dollar knows! So say the many pundits now calling the dollar’s recent slide a canary in the coalmine for America’s economy and stocks. That’s really stupid. But, they claim the S&P 500 surged to record highs with blinders on, ignoring the economy, soaring deficits, COVID containment struggles and more. But the dollar is properly weighing these risks, the story goes. And once stocks get wise, the party’s over. It’s an old story—and a tired one. History and simple logic show currency markets don’t predict stocks.
To say currency markets know something stocks don’t fundamentally misunderstands how markets work. Currency and stock markets are similarly efficient—like all similarly liquid markets. Both discount the same widely known information instantaneously. Pundits pontificate like stock investors are locked in bunkers without information--while currency traders are plugged in to every last bit of news and data. Yet it’s impossible for any single market to have any lock on unique information. US stocks and currencies, like the dollar, just have different drivers. Sometimes they zig together. Sometimes they zag divergently. Seeing relationships where none exist is deadly dangerous.
Simple human behavior explains stocks’ recent dollar divergence. US Treasury bills and bonds are the world’s preferred safe haven during crises. Long have been, very long. Hence, the buck stops here. So, the dollar generally strengthens during stock bear markets as investors sell overseas assets and pile into Treasuries. Recall 2008. As the global financial crisis snowballed, the dollar zoomed. From March 18, 2008—the wake of the Bear Stearns buyout—to its peak on the global bear market’s March 9, 2009 low, the dollar soared 25.7% against a trade-weighted currency basket. By early July 2011, the dollar had fallen -21.4%, surrendering all those gains. Stocks didn’t care. The S&P 500 more than doubled over that stretch, slightly ahead of international developed markets.
This year’s bear market and the new bull market, starting March 23rd, tell a similar tale. From January 1st through the bear market’s bottom, the trade-weighted dollar jumped 7.8% as investors worldwide piled into US Treasuries amid mounting COVID-19 lockdown terror. Then, the dollar reversed, falling -9.1% from March 23 – August 14. Holders and investors moved from their dollar safe havens into stocks here and abroad as they looked beyond the recession and fathomed a brighter future—like they always have at bottoms. Presuming anything more makes far too much of an overall tiny dollar wiggle. The greenback is barely down year-to-date and trading at levels seen quite frequently from 2014 – 2018.
Think further back. If dollar movements caused stocks to move up or down, history would show it. It doesn’t. Since 1973, when major European countries ditched their dollar pegs, the dollar rose in 25 years and fell in 21—basically a coin flip. The S&P 500 gained ground in 20 of the 25 strong dollar years. In the weak dollar years, it rose 17 of 21 times. In both it rose 80% and 80.9% of years—identical. That proves only that US stocks tend to rise much more often than not—regardless of how the buck bounces.
Viewed otherwise: Currencies trade in pairs. Hence, when the dollar weakens or strengthens it does so against other currencies. If a weakening dollar is bad for US stocks, it should be bullish for stocks outside America, where currencies are strengthening against the dollar. But US and non-US stocks tend to move together—highly correlated overall and have been for decades. They deviate only rarely, and relatively briefly—more proof dollar doomers’ claims are daffy.
The dollar is one of those things investors fear whether it’s up or down—much like oil. When it strengthens, pundits herald doom for US exporters. Or they paint it as central bank monetary tightening set to slam the economy. The repeat tendency to try to have it both ways makes dollar fears more about sentiment than economic or market realities.
Today, most observers still see stocks’ post March surge as detached from reality. Those who missed the market’s big bounce cling to any shred of evidence supporting their past bearishness—including the dollar’s decline. It is classic confirmation bias, the behavioral phenomenon causing humans to seek out information supporting pre-existing beliefs while shunning contradictory evidence (which I detailed in my June 23 column). Their doubts are your friends. As investing legend Sir John Templeton said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”
Worries about the greenback’s weakness are bullish—false fears always are. Today’s dollar doomers are merely laying the bricks in this nascent bull market’s Wall of Worry. Don’t let their fretting keep you from participating in stocks’ upward climb.