The U.S. dollar index is at a critical crossroads, recently surging to a 14-year high as investors bet that U.S. President Donald Trump’s eye-watering fiscal expansion will prove a replay of early 1980s Reaganomics. A cozy consensus is calling for an even higher U.S. dollar. Yet since the start of 2017, the dollar index has lost its upward momentum. Is an inflection point approaching?
To be sure, a long list of positives argues for a strong dollar. Most importantly, Trump’s policies could very well initiate stronger economic growth, higher inflation, and higher interest rates – and hence an even higher dollar.
But beware consensus thinking! It has been a long period of outperformance for the greenback. Several factors that drove the dollar higher are now likely heading in reverse.
First, what expectations are priced into the dollar? After years of massive outperformance, opinion is nearly universally bullish, bidding its value up to hazardous levels. Now, like Icarus soaring too close to the sun, the dollar’s wings may be melting. For example, in recent earnings outlooks, CEOs have repeatedly cited the strong dollar as a headwind for growth. This type of automatic “circuit breaker” ultimately leads to a weaker dollar.
Or consider Trump’s agenda for a manufacturing renaissance. To engineer this, a weak dollar is crucial. A manufacturing boom without a weak currency would be incredibly rare.
Trump knows this. Recently, his administration has been talking down the dollar, complaining that “U.S. companies cannot compete” because of the strong dollar. Expect this jawboning to continue.
Perhaps more importantly, consider investor expectations for growth outside of the U.S. A big surprise in 2017 will likely be much stronger growth in Asia and even Europe. Recent eurozone data continue to paint a picture of accelerating activity, subdued core inflation, ongoing monetary accommodation, and – most notably for investors – improving corporate earnings (even France is participating in this cyclical upswing!). This growth profile is underappreciated by most investors still fixated on Trump’s protectionist agenda damaging global trade.
Looking ahead, capital will continue to reward the best macro stories (particularly those with compelling valuations). Increasingly, these will be found outside the U.S.
Investment implications
Like other asset classes, currencies have a history of heading into extremes. The U.S. dollar could certainly move higher from here. But it is a crowded place with enormously high expectations. Any indication of a stumble could produce a great rotation out of dollars. Under that view, why not play a global reflation story by buying Europe and Asia, regions that have radically sharpened their competitiveness through currency debasement, are showing signs of earnings and economic acceleration, and if one insists on measuring valuation (in our post-modern world), trade on much cheaper multiples?
Courtesy Fundata Canada Inc. ©2017. Tyler Mordy, CFA, is President and CIO of Forstrong Global Asset Management Inc. Securities mentioned are not guaranteed and carry risk of loss. This article is not intended as personalized investment advice.
