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Earlier this year commodities prices were fairly buoyant
thanks in part to strong demand in Asia. The strength didn��t last long, however, and by summer weakness was evident in Europe
and China. Global growth slowed considerably in the months leading up
to October, when oil plunged below $90/barrel for the first time since
2012. Apart from weakening global demand and the growth of energy
supplies (thanks to fracking), the strengthening U.S. dollar has accelerated
this trend.
The strong dollar has resulted in an interesting feedback
loop: as the value of the dollar increases a combination of steady U.S.
economic growth and corresponding weakness in Europe and China make the
dollar attractive to foreign investors. Since many developing countries
are dependent on commodities, dollar strength tends to benefit the U.S.
economy at the expense of other countries. Below is a chart of our
favorite dollar proxy, the PowerShares U.S. Dollar ETF (UUP), which shows the
extent of the dollar��s impressive rise this year.
One of the key variables of the financial markets from
roughly 2001 until 2011 was a persistently weak dollar. The weak dollar
of those years, moreover, tended to be bullish for equity prices. The
reason for this is because the 2001-11 decade encompassed most of the
commodity price boom (or bubble, as some would have it). Many of the
stocks which outperformed in 2001-11 were of commodity-related companies such
as mining and oil/gas producers and explorers. The oil stocks were one
of the single biggest contributors to the run-up in the S&P 500 of the
years prior to the credit crisis, so it made sense that a weak dollar
benefited these companies since it boosted export prices and increased the
bottom line.
In recent years, the commodities bubble has deflated and
the stock market��s gains have come largely from
technology, financial sector, and non-commodity related stocks. A
stronger dollar typically benefits these types of companies, as was the case
in the booming corporate economy of the late 1990s. It appears that the
strong dollar/strong stock market dynamic of those years is making a comeback
and it couldn��t be happening at a more opportune
time. The middle class in desperate need of a ��bailout�� and a strong dollar is arguably
the best form of stimulus for consumers. It will also help companies
which cater to consumers by increasing profit margins and generating higher
sales volumes.
A dollar bull market, in other words, benefits everyone
except for those in the natural resource sector. While a strengthening
dollar may seem at face value to be deflationary, the danger of a rising
dollar index is only acute when the long-term economic cycle (the 60-year
cycle) is in its ��hard down�� phase. As of last month a new long-term up-cycle was born
and deflation from here will become less and less of a threat, at least in
the U.S. Indeed, ��deflation�� in terms of falling commodity prices and consumer prices is actually
beneficial to consumers when the 60-year cycle is in its ascending
phase. So we needn��t worry about the long-term
impacts of a rising dollar index from here either as investors or as
consumers.
Dollar weakness has also had the dual benefit of lowering
fuel prices, which in turn is benefiting consumers. Citigroup analyst
Ed Morse estimates that if oil prices stabilize near current levels, the
typical U.S. household will receive the equivalent of a $600 annual tax
cut. Another recent Citigroup analysis concluded that oil that��s 20 percent cheaper than the 3-year average price amounts to a
$1.1 trillion annual stimulus to the global economy.
Goldman Sachs estimates that every 10 percent drop in the
oil price stimulates 0.15 percent more consumption in the world economy;
moreover, it also increases demand for oil consumption by half a million
barrels per day. Clearly then commodity market weakness is more of a
blessing than a curse for the consumer-based U.S. economy.
Another factor which is helping the consumer economy
heading into 2015 is the drop in mortgage rates. Below is a graph
courtesy of the St. Louis Fed which shows the 30-year conventional mortgage
rate going back to the year 2006. The recent drop in
mortgage rates to below 4 percent has spurred a refinance rush. Demand
for refinancing rose 23 percent in the seven days through Oct. 17, according
to the Mortgage Bankers Association. The share of home loan applicants
seeking to refinance jumped to 65 percent �� the
highest since November 13 and up from 59 percent the previous week, according
to the MBA.
According to Businessweek, application volumes in
the week ended Oct. 10 doubled from a week earlier at mortgage lender Quicken
Loans. Mark Vitner, senior economist at Wells Fargo Securities,
believes the refinancing ��boomlet�� will provide an added lift for the financial sector in the fourth
quarter. The strength of the refinancing demand can also be seen in two
invaluable charts, which happen to have important implications for the overall
financial sector. The first chart example is of the PHLX Housing Index
(HGX), which shows a potentially bullish consolidation pattern.
The next chart exhibit shows the progression of the Dow
Jones Equity REIT Index (DJR) over the last past few weeks. The REITs
tend to be more immediately sensitive to changes in interest rates and often
lead the broader housing sector. Note that DJR is in a relative
strength position versus both the HGX as well as the S&P 500.
Both DJR and HGX suggest that the housing market, which
showed some weakness in the third quarter, will likely benefit from the
recent mortgage rate drop as well as last month��s
long-term Kress cycle bottom. Next year could finally be the year that
sees prospective middle class homebuyers emboldened enough to finally begin
taking the plunge back into the mortgage market once again.
Some Wall Street analysts question how much longer the
bull market in equities can continue if the dollar remains strong. They
would do well to recall the magnificent period between 1997 and 1999, which
was the last notable period of dollar strength. At that time the U.S.
economy was white hot, stock prices were on a relentless upward march, energy
prices were low and the U.S. was the undisputed leader in attracting foreign
capital inflows. Again I would emphasize the point that as long as the
long-term Kress cycles aren��t declining, a strong
dollar can only boost America��s economic and
financial market prospects.
Unfortunately, due to the reticular nature of the global
economy there is no such thing as ��everyone��s a winner.�� Gains in the U.S.
economy can only come at the expense of foreign countries whose economies are
much more highly sensitive to commodity prices than ours. As the dollar
strengthens and energy prices plunge, for instance, oil-dependent nations
such as Russia and Venezuela will weaken. On the other hand,
industrialized nations which are highly dependent on exports stand to gain as
the dollar strengthens. History teaches that a persistently strong
dollar will eventually undermine several important foreign economies, which
will in turn lead to the next global crisis. (As one historian has
remarked, ��The world economy progresses only at the
expense of crisis.��)
From the standpoint of middle class America, the strong
dollar couldn��t be more welcome. The middle
class deserves a break after all the suffering of the last six years, even if
it means other countries are suffering at our expense. Americans, after
all, have no reason to feel any allegiance to the global economy and are
rightly concerned with their own prospects. With any luck, the strong
dollar will continue into 2015 just as the U.S. enters the ��sweet spot�� of the decadal rhythm.
There has never been a losing year for stocks in the Five
year of the decade; moreover, there has hardly been a losing year after a
Congressional election year. And with the 60-year cycle having recently
bottomed, all the major yearly Kress cycles will be up next year.
Combine this with a domestic economy that is showing signs of wanting to
finally break out and 2015 is shaping up to be an across-the-board ��good�� year for most Americans, the first
in quite some time.
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