Dollar, Dollar Bills Y'all

As is typical in the financial media, the headlines generally follow the developments in financial markets, not precede them. Investor groupthink also follows this pattern and is rarely aware of what's happening until it's already occurred and the time for repositioning has passed.

That’s why I have said repeatedly that the best edge that an investor can have is gained developing a method for better understanding what is happening right now, in the present and then being able to articulate that into the positioning of his portfolio.

Most investors spend their time analyzing what has already happened, like moving markets hundreds of basis points based on GDP numbers that reflect economic activity from 5 months ago. Or they spend their time forecasting what will happen in 3 to 6 months, or longer.

Markets Like the Weather

With all of the sophistication and technology in meteorology these days, weather patterns can’t be accurately predicted further out than 5-7 days. Some would say getting it right the next day is a stretch.

So, if weather patterns can’t be accurately predicted, does it make sense to believe that we can predict what will occur in an ecosystem as vast and complex as the global economy and financial markets?

This pattern of news and “insight” following movements in financial markets rather than preceding them has never been more true than the last couple of weeks.

Let me preface my comments by saying that I carefully curate the information I take in on a daily basis. And as such, I have review a very few select sources that I have honed over the years.

However, to keep things fresh, I routinely visit popular financial blogs, websites, and Twitter accounts of mainstream financial pundits and organizations to get a feel for what “The Street” is thinking and spewing.

 

Dollar Doom?

I can’t remember for the life of me more headlines pertaining to the US Dollar’s recent strength and its implications than in the last week to 10 days. For context, headlines began percolating after the USD hit a 4-year high of 86.75 on October 3, which would mark the top of a 5-month, 10% move in the greenback. Sixty percent of that move occurred between August 19 and October 3. That is a monster move for a currency over that timeframe.

One article that caught my attention, was titled “The US Dollar Is About to Inflict Carnage All Around the Planet.” With a title like that , how could I not look?

The author’s main points were that a strong USD will kill everyone including emerging markets, Japan and the Eurozone.

He’s not alone, most of the articles I perused said similar things but also added in how a strong USD would crush US corporate earnings because S&P companies rely so heavily on international revenue streams. The truth is that its reckless to pin cause and effect in the global markets on just one market or event. The financial markets are too complex for that.

And as I’ve said repeatedly, the two most important drivers of asset prices are economic trends and how central bankers respond to those trends. But to push back a bit on this guy’s conclusion and the general feeling out there that a strong USD will collapse the world, let’s start with the fact that the US Dollar has been strengthening for 3 years, not 5 months or 2 months.

 

Fear vs Facts

The USD bottomed in 2011 and has been appreciating ever since to the tune of 15% over those 3 years. So, it stands to reason, based on his understanding that markets around the world should have been crippled. That’s not the case. Emerging markets (EEM) up 28%, Eurozone (FEZ) up 57%, Japan (EWJ) +29% and the S&P 500 (SPY) up 88%.

Now obviously this 3-year time period also has included unprecedented monetary policy in addition to a strengthening US dollar. But my point is made all the same. A strong USD does not necessarily equate to the end of the world.

If we look back at a more normalized period of time, 1995-2001, we see a similar pattern emerge. Specifically, the USD bottomed in April 1995 and gained 50% over the next six years, before peaking in early July 2001.

Surely, if his reasoning is sound, then a 50% move upward over 6 years would have a negative impact on world markets? If it did, the returns of various asset classes don’t bear that out, here are the returns of various markets over that same time period:

S&P 500 (SPX)  +147%

German Equities (DAX)  +215%

Brazilian Equities (Bovespa)  +390%

Hong Kong Equities (Hang Seng Index)  +58%

Not to mention that the US enjoyed one of its most prosperous economic times throughout this time period as well. And as a side note, to all of the bloggers out there who believe the recent decline in Oil is entirelyto blame on USD strength, WTI Crude gained 44% during the dollar’s strength from 1995 to 2001 and is up 14% over the last 3 years, even accounting for the bloodbath over the last 2 weeks.

Let’s assume this guy, and many like him, weren’t missing a big chunk of the picture, their timing leaves a lot to be desired. I think the USD has hit an intermediate-term top and that we are more likely to see 84 or even 81 on the USD before we see 89.

Only time will tell which of us is right.

But in my experience, markets that move as far and as quickly as the USD has do two things:

Catches people off guard, causing them to freak out.
This in turn, leads to unreasonable amounts of hyperbole and trend extrapolation.

And generally speaking the right move is to “fade” what these people are saying and doing.