Crossing Wall Street Review – September 15, 2017
By Eddy Elfenbein, editor of Crossing Wall Street and portfolio manager of the AdvisorShares Focused Equity ETF (Ticker: CWS)
“Fear is an emotion, not a stock indicator.” – Coreen T. Sol
After eight and a half years, the stock market is still hitting fresh all-time highs. The Dow, S&P 500 and Nasdaq all broke out to new highs this week. Here’s a cool stat: since the election, the S&P 500 has added $2 trillion in market value, and half of that is due solely to the tech sector. The much-hated rally marches ever onward.
The S&P 500 even came close to breaking through 2,500 for the first time in its history. Thursday’s intra-day high was 2,498.43. For some context, the S&P 500 first broke 25 in 1929, and it smashed 250 in 1986.
The historically minded observer may have noticed that those milestones came just before some unpleasantness. I still think we’re pretty safe from any nasty downturns. Inflation, interest rates and unemployment are low, and the economy continues to hum along.
In this week’s CWS Market Review, I want to focus on a key aspect that’s been helping the market this year, and that’s the weak U.S. dollar. This is a crucial factor, and it’s not widely understood. The currency markets can have a big impact on the stock market, and I want to explain what’s happening.
The Weak-Dollar Rally
The U.S. dollar has not been in a good way this year, and that’s actually a good thing. Look at some the numbers. Earlier this year, a British pound was worth $1.20. Now it’s going for $1.34. The euro’s gone from $1.05 to $1.19. The euro rally may have further room to run. The Financial Times recently reported that “speculators were holding the biggest net long position on the euro against the dollar since May 2011.”
This is important to understanding what’s happening in today’s market. Despite a good year for stocks, both the Dow and S&P 500 would be down for the year if they were priced in euros. The slumping dollar has not only helped us rally, but it’s affected the nature of the rally. Let’s dig into this some more.
Right now, the economy of the United States is out of sync with much of the developed world, especially Europe. The economy in Europe is basically where we were two or three years ago. Only now are things starting to look up for the Old World. This week, we learned that the British unemployment rate dropped to a 42-year low. Unemployment in Germany is the lowest since reunification. Even France is improving.
As a result, there’s a growing belief that Mario Draghi and the European Central Bank will pull back on their “kitchen sink” strategy for monetary policy. On top of that, the plan for more rate hikes in the U.S. seems to have faded. Capital naturally flows to where it’s treated best, and lately, that’s been away from the USA.
Normally when we see the dollar slump, it often means that commodity prices are rising. In turn, that’s good for commodity stocks. But what’s interesting is that energy stocks haven’t joined in the rally. The energy sector got slammed in 2014-15. While last year saw a modest recovery, this year has been more of nothing. OPEC is even talking about extending its production cuts. The two biggest energy companies are both down for the year.
Normally, we see materials and energy stocks behaving somewhat alike. Not this year. Why? That’s hard to say. It may reflect an emerging global recovery that’s skipped over the energy patch. Nearly every kind of metal has been booming. Zinc recently touched a 10-year high. Copper’s had a strong year as well (except for a nasty correction in the past week). Aluminum is up as well. And for the goldbugs, gold is up smartly this year.
This tells me that there’s demand for industrial metals, which means there’s a demand for industry. We’re seeing a similar effect happening in defensive stocks. Healthcare and consumer staples normally tack each other fairly well, but not this year. It’s been a good year for healthcare stocks. But the consumer staples stocks have lagged, sometimes badly.
Especially weak are lately has been the financial sector. Typically, financial stocks rally when short-term interest rates rise. Or more accurately, the hope for higher short rates rises. Financial stocks soared after last year’s election, but haven’t done much of anything since then. August was an especially bad month for financials.
The tech sector has also been very strong this year. Many of the tech stocks have a global reach, so the weak dollar is a positive.
The weak dollar has also followed the small-cap sector lower. Both peaked after the election late last year, and both have drifted lower this year. This may be having an effect on the market’s appetite for risk. With volatility so low, there’s not much room for action for excitable day traders. As a result, this may be pushing them towards more extreme markets like bitcoin. I can’t be positive, but there may be a direct relationship between the stock market’s calmness and bitcoin’s frenzy. The virtual currency is down by one-third in the last 12 days.
What to do now: Wall Street is largely in a state of limbo until Q3 earnings season begins in another month. The recent economic numbers look good. The Fed may even be leaning towards a December rate hike. (I hope not, but it’s possible.)
It’s important for investors not to be scared out of this market. The fundamentals are strong, but the market is always vulnerable to a near-term hit. I also think it’s possible that a dollar rally could cause an internal market rotation.
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