April 2018 Market Summary by Jack Moller, CFP®

Last month I wrote about how so many different markets seem to be at serious inflection points with the jury out on whether or not we were simply in consolidation mode of a continuing trend or if these markets were changing course.  As I write this, it appears that we may have received a verdict with one of the key markets having experienced a strong trend reversal while the jury remains out on the others as they continue in sideways patterns.

U.S. Dollar Strength

The big change seems to be that the dollar has suddenly shown great strength after trading sideways for the past three months or so.  Of course, we never know if this is a false move or not but it sure seems to have confounded the experts and surprised the market which had perhaps complacently bet on the falling dollar continuing.  In fact, many surveys indicated that most of the speculators held large short positions, betting on continued decline in the dollar.  April’s strength could be a simple “short-covering rally” but it seems to me most markets bottom out when the shorts switch their bets either voluntarily or forcefully.

The dollar reversal (if it continues) could have some major ramifications for the economy and other markets.  Some possibilities to consider:

• Petering out of inflation concerns.  If the dollar continues to strengthen, it should begin to relieve the upward pressure on prices as goods produced overseas automatically become cheaper.  Might concerns about deflation begin to resurface?  Well, certainly nobody is talking about deflation in the U.S. anymore these days as the focus has shifted to inflation. I like to at least consider possibilities that nobody else is watching.
• Long-term interest rates may stop climbing soon.  Continued dollar strength might put a ceiling on long-term interest rates regardless of whether the Fed continues to raise short-term rates.  Our interest rates are near the highest in the world and would likely prove to be a magnet for non-U.S. investment funds.  It would give the international investor the opportunity to get better rates and benefit from earning these in an instrument denominated in a currency (the dollar) that is appreciating.  Funds flowing into our bonds would likely put upward pressure on prices and correspondingly downward pressure on yields.
• Impact on the stock market might be mixed.  As I’ve written about in previous commentaries, a shift to an appreciating dollar would shift the wind from being a tailwind for international equities to a tailwind for U.S. equities.  This is simply because the strength or weakness of the currency in which the stocks are denominated.  However, it is not that simple because the currency swings can have an economic impact as well.  Thus, as the dollar gets stronger, goods produced in the U.S. get pricier in world markets possibly cutting back on demand and sales.  It might be beneficial to further subdivide the “stock market”.
• U.S. stocks.  The economic impact of a rising dollar would likely fall unevenly on various companies.  Generally speaking, companies with significant overseas sales might be hurt.  Larger companies might feel most of the pain as they tend to have greater percentages of international sales.  In contrast, smaller companies tend to focus more domestically so would likely not be as significantly impacted by a strong dollar.
• Non-U.S. stocks.  Again, generally the stronger dollar would help economically as goods produced in these other countries will automatically become more competitive price-wise.  Again the tradeoff is the security is denominated in a currency that is depreciating. 

However, the emerging market stocks might be impacted somewhat differently than their developing market brethren.  The potential risk in emerging markets is that some of these economies are burdened with much debt that is denominated in dollars.  Thus, as the dollar gets stronger (and as interest rates rise), maintaining this debt becomes more costly and challenging.  This could become a problem if the dollar strength persists though at this point is unlikely to cause these problems.  On the other hand, for many emerging market indices, Chinese companies receive the biggest allocation.  While we know that China is certainly a rapidly growing economy, albeit at a slowing rate, we also know that China currently seems to be in the economic cross-hairs of the Trump administration in the trade area.  This could be problematic for their equities over time.

Having said all this, I don’t want to jump the gun.  Right now the dollar is only back to where it was in December of last year so if the rally stalls here it likely won’t be too impactful.  And, it is important to keep in mind that a stronger dollar seems to fly in the face of the Trump administration’s strong push to improve our trade balance so they may act.  Let’s keep an eye on the dollar and how it might impact these other markets.

Other markets remain in trading ranges

So far, only the dollar seems to have broken out of their trading ranges of the last several months.  A few key levels that we will be watching to see if these trends do end up breaking out one way or other:

• S&P 500.  As I noted last month, the S&P continues to trade just above its (rising) 200-day moving average.  It hasn’t been able to bounce too far yet but also hasn’t broken through to the downside either.  If it were to fall decisively below the 2,600 level it might mean the uptrend has been broken.  Until then, we’ll just assume we are experiencing a pause within the multi-year uptrend.
• Bond Market.  During April, interest rates began to rise again with everyone looking at the psychologically important 3% level to see if the 10-year treasury rates would finally break through.  They did, and then nothing happened.  As I write this these rates have backed off slightly to about 2.95%.  It seems like that 3% level is still offering resistance.  If rates do meaningfully break through 3% and stay above that level, then we might finally be able to “call” the end of this three-plus decade bull market in bonds.  But, let’s not jump the gun.