Markets are difficult. Anyone who says differently is a fool or a liar. Entering this year, many were looking at the potential for inflation to rear its ugly head. However, it has been hard to capitalize. Imagine this: on January 1st, 2022, you were given all the future inflation readings for the year. How would you have invested your money? Gold? Bitcoin (“digital gold”)? Inflation-protected government bonds? The correct answer, and its implications, may surprise you.
The U.S. dollar has been one of the best-performing assets year-to-date. How is it possible that your money, which is clearly buying less and less food, fuel, and housing, is doing well at all, let alone outperforming? It is important to understand that everything is relative. If you were to go on a trip to most places in the world right now, the amount of foreign currency you would receive in exchange for your dollar would be higher than at the beginning of the year. This represents outperformance in the foreign exchange market. Relative to stocks, bonds, and even gold, just treading water by holding cash has been more attractive than the double-digit negative returns by each of those asset classes. Those owning “real” assets like a house have seen that portion of their net worth grow, but higher interest rates probably prohibit taking advantage of those higher Zillow prices. After all, you will have to live somewhere when you sell, and a 7% mortgage is much less attractive than a 3% one.
A strong dollar has massive implications beyond being able to take a cheaper European vacation. For starters, multinational corporations based in the United States conduct business in many different currencies. A strong dollar makes it more expensive for them to convert those foreign currencies back into their home currency. Fewer dollars due to unfavorable conversion factors means lower profits for those types of companies. Additionally, if you hold international stocks in your portfolio, part of the relative weakness is due to that currency conversion.
Another byproduct of a strong dollar is the adverse pricing of commodities like oil for foreign countries. The Dollar is the world’s “reserve currency,” which essentially means it is the preferred means of transacting business across borders – a common denominator if you will. Commodities are bought and sold on the open market in dollars which means that despite higher prices for basic necessities at home, we have it relatively easy. Those living in a country like Japan are not only feeling the pinch from higher oil prices in dollars, but they also have seen the Japanese yen depreciate by a whopping 25 percent versus the dollar just this year. These types of price shifts will have far-reaching implications in the years to come.
It wasn’t always like this. I recall a few famous entertainers and supermodels requesting to be paid in euros in 2007 based on the euro’s relative strength versus the dollar. Relative strength ebbs and flows, and our current situation is merely the most recent chapter in an ongoing saga. If you are looking for a turning of the tide in the stock market, keep your eye on the relative strength of the dollar, as a sign of weakness could signal calmer seas. King Dollar, as it is sometimes referred to, rules the international finance scene with an iron fist, and any chinks in its armor can give us a breather.
Author: David Rath, CMT, CFA
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