One of the occupational hazards of being in the investment and wealth management business is the necessity of following financial headlines from day to day, and we have not been able to figure out a way to avoid having to do so. We admit to often finding ourselves amused by the fixations of CNBC and their cohorts in the financial media. One day Greece is in the headlines, and all is doom and gloom. The next, the ECB is coming to the rescue, and happy days are here again. Then China prints a disappointing growth number, and down go the markets, only to head back up when the People’s Bank lowers reserve requirements for the banks and all is well again. Not to mention parsing every word out of Janet Yellen’s mouth for clues to the U.S. economy and markets.
The thing is, not everything the financial media obsesses over actually correlates to market direction. For example, the dollar has been in the news quite a bit this year, as it was in the second half of 2014. From 6/30/14 to 3/31/15, the U.S. dollar surged against a basket of major currencies, rising over 23% over that period. While most U.S. investors probably think of a strengthening dollar in terms of its potential impact of the value of any foreign securities they may be holding, many also wonder about the potential impact on U.S. securities, especially stocks.
Many investors noticed a few years ago when U.S. stocks rallied off of weakness in the dollar. But over the past 20 years, there have also been two extended periods when the S&P 500 and the dollar were simultaneously in rally mode. The conclusion? A report released on April 10th by Citi Research, a division of Citigroup Global Markets, concluded: “The dollar generally has not determined stock price direction for the broad market but there is some correlation with large and small caps, though the relationship is not consistent.”
In the near term, the rise in the value of the dollar is expected to have some influence on corporate earnings results for the first quarter. Nearly 20% of S&P 500 companies have warned investors on first quarter earnings, mentioning that the dollar’s strength did influence results. It has been estimated that North American public companies could give up more than $25 billion in revenues in the first quarter due to currency-related volatility, and that the strong dollar dinged earnings by almost $19 billion in the fourth quarter of 2014. If the dollar continues to rally, expect some companies to implement currency hedging strategies to help mitigate the hit to earnings.
Having acknowledged the influence of the dollar’s movements, we believe it is important for investors to keep an eye on the bigger picture. Despite all of the fluctuations in the dollar since 2007, which includes the 2008-2009 financial crisis, global nominal GDP still rose from $57.46 trillion in 2007 to $77.30 trillion in 2014, an increase of almost $20 trillion, according to the International Monetary Fund. In other words, world economic output has expanded by an amount larger than the size of the U.S. economy in just the past seven years. Not bad considering all the world has been through!
Regarding your portfolio, we continue to recommend overweight exposure to U.S. equities, and specifically the mid-cap (medium sized companies) portion of the U.S. economy. We are underweight international equities, although we find valuations attractive and are looking for our indicators to confirm increasing exposure there. We continue to underweight fixed income, as we find valuations in that space far too expensive to warrant anything other than minimal required exposures there. We would highlight that one of our international positions involves European exposure hedged against continued dollar strength, a decision that has added value to your portfolio.