Get Ready for a Dollar Bull Market

Get ready for a multi-year bull market in the U.S. dollar.

Yes, you heard that right.

No statement about investing right now could feel more wrong. And this is why it's probably time to start swimming against the tide.

First, I'll make a mundane case based on timing. Consider the following chart:

Since the Bretton Woods monetary system started breaking down under the strains of the Vietnam War and Great Society spending, there have been three dollar bear markets, each lasting roughly 10 years: 1968 to 1978, 1985 to 1995 and the current dollar bear market, which started in February of 2002. Currently the dollar is right against the lower bound of its long term trading channel.

You might say that the major currency index is no longer relevant due to the rise of emerging markets. Here is the broad dollar index (which incorporates all currencies on a trade-weighted basis) in real terms (adjusting for differences in inflation):

Not much difference in the timing of the bull and bear markets. Against the broad basket, the dollar has punched below the lower bound of its long term trading range, which means it might just be ready for a snap-back.

But things are so much worse now, aren't they?

In the mid-to-late 1970s, we experienced the loss of a major war and the resignation of a president, soaring inflation and commodity prices, union militancy, provocations by tin pot despots in the Middle East, years of bear markets in both stocks and bonds, weak leadership at the Fed and a general sense of American decline. Plus you had polyester leisure suits and disco.

In the early-to-mid 1990s, we were experiencing the "hollowing out" of American manufacturing and "downsizing" of white collar jobs, years of a brutal bear market in real estate, Japan was eating our lunch, years of large fiscal deficits, the aftermath of a major banking crisis and credit crunch that had followed a boom in high yield and real estate debt, a divided government with Congress controlled by firebrand conservatives that had forced a shut down of the Federal government and a general sense of American decline. At least we had flannel shirts and grunge rock…better than the late 1970s.

Hmm…for the most part these periods of time sound pretty similar to today.

There are major differences, of course. For example the transition to the dollar bull market involved a horrible recession in the early 1980s, while in the mid-1990s the transition was relatively smooth (in the U.S. anyway).

So what happens in a dollar bull market?

  • Real interest rates rise. This might come from a rise in short term interest rates or a shift to falling prices or very low inflation (or both).
  • US technology is hot. Leading edge technology attracts a lot of investment. The great venture capital bull markets coincided with the dollar bull markets of the early 1980s and late 1990s.
  • US business investment rises. Higher real interest rates attract investment capital back into the US, which flows into software and business equipment.
  • Emerging markets crash. It is no coincidence that the great emerging markets crises occurred in the early 1980s and late 1990s. The strong dollar draws investment dollars away from emerging markets and back to the US. This occurs after 10 years of an emerging market bull market during which untold unbalances build up. Would you really be surprised to find out that much of China's growth has been built on a mirage of cheap credit and wasteful infrastructure spending?
  • Commodities and farm prices crash. A rising dollar is a net negative for commodity prices (which are priced in dollars). Plus, it usually turns out that much of a commodity bull market is built on financial speculation, which flees once it becomes clear that momentum has shifted.
  • Large cap outperforms small cap. The long-awaited rotation from small cap to large cap and from value to growth might finally occur.

I am assuming that the transition to a dollar bull market will take a year or more. My plan is to gradually start moving to underweight in commodities, emerging market stocks and foreign bonds. As the Fed transitions from accommodating to neutral or restrictive, or if there is an inflation or financial crisis in emerging markets like China, there could easily be a major bear market US equities. I will wait to see how the market handles the transition in monetary policy before moving to overweight in large cap US stocks. There is also a dollar bull ETF, the Powershares DB USD Bull ETF (ticker: UUP), for those that want to get more aggressive.

I remember people yelling at me for being an idiot when I was buying gold and silver back in 2002. People argue vehemently against me now. I must be on to something.

I am not a financial adviser and write these articles purely for my own amusement. Please consult your financial adviser before acting on any of the recommendations posted here.

2 thoughts on “Get Ready for a Dollar Bull Market

  1. Interesting post and a strong thesis on the dollar. What does it say for the dollar that grunge died out yet hip hop remained?

    Like

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