The U.S. Dollar – Public Enemy #1
By David Nelson, CFA
A myriad of factors seem to be colliding forcing some of the world’s top strategists to the sidelines. The approaching election, a confused Fed and stretched valuations weigh on sentiment as the markets here continue to churn forcing investors to bounce from one sector to the next searching for the Holy Grail.
The U.S. Dollar (DXY) is the single biggest headwind for stock prices and hence Public Enemy #1. Whether it’s the prospect of a year-end Fed hike or the relative weakness of other currencies the spot rate is approaching the highest levels of the year posing a significant threat to U.S. multinationals. The revenue translation cuts right to the bottom line as it becomes increasingly difficult to compete with overseas counterparts.
In addition the longer term picture shows the dollar’s rapid ascent threatens to take out a significant double top implying even higher prices as the year unfolds.
Even more important than the prospect of a rate hike is the secular decline of the Euro. Yes quantitative easing is big factor in Euro weakness but I think the chart above speaks to bigger problems ahead for the currency and maybe the European Union itself. Brexit may prove to be just a shot across the bow in what could trigger other exits down the road.
While my prediction on Bloomberg TV in 2011 that the Euro would eventually fail within 5 years isn’t going to pan out this year, I’m confident in my thesis and stand by my statement; “You can’t have a common currency without a common government!”
One asset class thriving in face of a rising dollar is WTI Crude (USO). Typically a strong dollar acts as a headwind for the commodity but crude has broken out to a new 52 week high. Over the weekend Gulf oil ministers were meeting in Riyadh along with Russian counterparts to discuss production cuts that would likely take effect in November. Both OPEC and Russia are coming off record output so it begs the question just how much are they willing to cut and more importantly can they control the cheating.
As a reminder Saudi Arabia abandoned its role as swing producer back in 2014 forcing crude into a near two year slide looking to wipe out the U.S. shale complex. In what today looks like a failure, it seems all parties have come back to the table. Recent history isn’t on their side as wide spread cheating has become the norm and all parties need as much cash flow as they can generate to maintain budgets. Already Iraq Oil Minister Al-Luaibi speaking from Baghdad has asked that Iraq be given an exemption from any production cuts
If crude is going to maintain recent gains I believe it will come from increased economic activity and not OPEC trying to relive its days as a thriving cartel. Each dollar crude rises brings more U.S. production back online.