The Dollar Bounces Back

The reversal in the U.S. dollar is the big news in the markets.

The dollar soared after the election but began a steady decline in January that didn’t stop until recently. At one point, the dollar was down almost 10% for the year against a basket of major currencies. That was its longest and steepest decline in about a decade.

The low for the dollar was reached in September, and it already is up about 3% from that point. Several factors contributed to the dollar’s recovery.

Of course, the Federal Reserve started tightening monetary policy and, in recent statements, convinced many investors that it might tighten more than is priced into the markets. Higher interest rates and tighter monetary policy generally are positive for the currency. Though central banks in the United Kingdom and Europe also talked about future tightening, the Fed has been tightening while the others are only talking about it.

International events also are helping the dollar. The independence vote in Catalonia and a better-than-expected performance by the anti-establishment party in the recent German election caused some investors to become unsettled about the future of the European Union and stability in Europe. They sought the safety of the dollar.

Also causing a flight to safety are the headlines about North Korea and Russia. The recent run of terrorist incidents in Europe have also helped the dollar.

Of course, it’s not clear this is a long-term reversal in the currency. But the short-term technical indicators are positive. The dollar is above its 50-day moving average and closed above some generally accepted resistance levels. Also, the last quarter of the year typically is a good period for the dollar.

A strong dollar typically reduces revenues and earnings at U.S.-based global companies that earn most of their revenues overseas. It also typically triggers a move to smaller company stocks. But the move to smaller company stocks might have happened already. The small company stock indexes had strong returns recently, recovering from a slump earlier in the year. The Russell 2000 is up 7.41% for the last three months and 12.25% for the year to date.

A rally in the dollar also could hurt returns for U.S. investors in global stock and bond markets.

I’m not expecting a strong, sustained rise in the dollar. I believe it declined too much in 2017. But it’s not substantially undervalued. A bounce was not a surprise. For now, though, I believe the best growth prospects are outside the United States, and non-U.S. stocks should continue to generate higher returns.

The Data

There wasn’t a lot of economic data in the last week.

Inflation showed some life in the Producer Price Index. The index rose 0.4% for the month and is up 2.6% over 12 months. Some of that increase is due to energy price increases following the hurricanes, which rose 3.4% for the month. But services prices also rose 0.8% for the month, indicating that the tight labor market is starting to increase inflation.

The NFIB Small Business Optimism Index is becoming volatile. It spiked after the election, peaking in January. It began sliding, but then rebounded last month to just below the January high. But this month it declined 2.3 points to 103.0. That’s the lowest level of 2017. The decline still leaves the index higher than any pre-2017 year dating back to 2006.

Consumers might be loosening up a bit. The Consumer Credit report revealed a sharp increase in credit card use. Credit use rose $5.8 billion for the month, while auto and student loans declined for the month. This data is volatile on a monthly basis, so we’ll have to wait to determine if this is a monthly blip or a new trend. We’ll see if it is reflected in tomorrow’s Retail Sales report.

Last week’s Employment Situations reports were worse than expectations, but that appears to be largely a result of the recent hurricanes. There was a decrease of 33,000 in the number of jobs in the economy, with private payrolls declining by 40,000. Even so, the unemployment rate dipped to 4.2%.

Perhaps more importantly, average hourly earnings increased by 0.5%. That ties last July (which was revised higher to 0.5%) as the highest level of the expansion. The 12-month increase in earnings is 2.9%, which ties last December’s number as the highest of the expansion.

We’ll have to wait a few months to see how much the hurricanes skewed the data, but at this point it appears the labor market is very strong and might finally be leading to higher wage increases.

There weren’t any new trends in the JOLTS (Job Openings and Labor Turnover Survey) report. This report is more detailed than the Employment Situation reports but lags them by a month. As has been the case for about two and a half years, there’s a large gap between the number of job openings and the number of new hires. This indicates the economy probably is at full employment and employers will need to increase compensation if they want to fill those job openings.

New unemployment claims declined by another 15,000. The effects of the hurricanes on new claims are declining rapidly and bringing the claims number close to the historic lows of earlier this year.

The Markets

The S&P 500 increased 0.74% for the week ended with Wednesday’s close. The Dow Jones Industrial Average did better again, gaining 0.98%. The Russell 2000 declined 0.05%. The All-Country World Index rose 0.75%. Emerging market equities returned 1.39%.

Long-term treasuries increased 0.10% for the week. Investment-grade bonds declined 0.04%. Treasury Inflation-Protected Securities (TIPS) rose 0.18%. High-yield bonds gained 0.14%.

The dollar fell 0.49% but still is up 1.31% for the last month.

Energy-based commodities rose 1.36% for the week. Broader-based commodities gained 1.12%. Gold returned 1.14%.

Bob’s News & Updates

Do your heirs know how to handle an inherited IRA? If not, they’ll join the long list of heirs who made simple mistakes that triggered additional taxes and penalties. To avoid this result, be sure your heirs have a copy of Bob Carlson’s Guide to Inheriting IRAs.

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Some Reading for You

Here are some good summaries of the latest Nobel Prize Award winner in Economics, Richard Thaler.

Dr. Ed Yardeni reviews the history of stock market valuation measures and how effective they are at indicating the market’s direction.

We’ll have several more years of growth and stock market gains, predicts Byron Wein of Blackstone.

I comment and link to these and other items on my public blog.