A Falling Dollar And Rising Bond Rates Could Be Good For Stocks

 |  Includes: SPY
by: Louis Navellier

The S&P 500 fell 1% last week, but many foreign stock markets, especially in Asia, were hit harder than that. Japan's Nikkei plunged 6.4% on Thursday, entering official bear market territory, falling 20% from its May peak. Foreign investors are also unloading U.S. Treasury bonds in record amounts, so it appears that one of the safest havens in the coming months might very well be the U.S. stock market.

A Falling Dollar is Usually Good for Stocks

In August 2011, S&P caused a market panic by downgrading U.S. debt. Last week, S&P upgraded the fiscal outlook for the U.S. from "negative" to "stable," due in part to a shrinking federal budget deficit, but the market basically yawned. The dollar didn't rally, either. Despite rising bond yields and rising consumer spending, the U.S. dollar lost its "mojo" and has significantly weakened against other major currencies. It is now at a 3.5-month low against the euro and a two-month low against the Japanese yen.

This is great news, since the dollar had risen too far, too fast earlier this year, crushing profits for multinational companies, especially exporters. Now that the dollar is back on its long-term slippery slope, corporate profits should start to rise in the second half of 2013 as companies with global markets will be getting paid in appreciating currencies. As a result, the earnings growth rate for the S&P 500 should rise.

A weaker dollar also causes commodity prices to rise. On Friday, the Labor Department reported that the Producer Price Index [PPI] rose 0.5% in May, due largely to higher energy (i.e., gasoline) prices, which rose 1.3% last month. Overall, wholesale prices (for both the core and overall PPI) rose at a 1.7% annual rate in May, up from 0.6% in April. This increase is mostly caused by the latest decline in the U.S. dollar.

These trends are mostly positive for stocks, which have historically been a great inflation hedge. A weak dollar also typically helps tourism, manufacturing, and exports. Just like Japan boosted its GDP growth to an annual rate of 3.5% in the first quarter, primarily by lowering the yen to boost exports, a weak U.S. dollar should boost U.S. GDP growth, like it did from 2002 to 2008 when the dollar fell 37% on a trade-weighted basis against 15 major currencies. Overall, a weak dollar has the potential to boost earnings, the stock market, and our GDP.

Rising Bond Rates are also Typically Good for the Stock Market

The yields on 10-year Treasury bonds surged from 1.66% in early May to 2.25% on June 12, before settling back to 2.14% on Friday. This is great news, since rising bond yields cause bond prices to fall, often sending income investors back to the stock market. This also happened in 1995 when rising interest rates accompanied the most impressive stock market rally from 1995-99.

According to Bespoke Investment Group, the stock market correlation between 2013 and 1995 is a lofty 0.96 (with 1.0 being perfect correlation), making 2013 "more similar to 1995 than any other year in the S&P's history." That's encouraging because the S&P gained 34% in 1995 and went on to score 20% or larger annual gains in each year from 1995 to 1998. So, despite Wall Street's biggest concern - an end to QE and a rise in bond rates - the stock market might perform just fine if long-term rates keep rising.

Rising bond rates seem to be the biggest concern on Wall Street now, especially since the Federal Open Market Committee (FOMC) meets again tomorrow. Of the 19 major Fed officials that attend the FOMC meetings, there are only four hawks. Furthermore, only one hawk is a voting member on the FOMC, so the doves are clearly in control. To me, this means that the money pump will likely remain on for now. I expect that the Fed will pump $85 billion per month for as long as Ben Bernanke is Fed Chairman (until at least January 2014). He will effectively keep his "finger in the dike" as long as he remains in office.

Specifically, the Fed will not stop quantitative easing as long as U.S. economic growth remains tepid and our unemployment rate is stuck at around 7.5%. In addition, the Institute for Supply Management (ISM) shocked economists last week when it announced that its manufacturing index declined to 49 in May, down from 50.7 in April, the third straight monthly decline and the first time the index has fallen below 50 since 2009. Any number under 50 signals contraction, so I expect that the doves in control of the Fed will keep throwing money at the economy. I would be shocked if the Fed cut back on QE this summer.

Stat of the Week: Retail Sales up 4.3% (year-over-year)

The economic news last week was largely positive, especially Thursday's news that retail sales rose 4.3% in May (over May 2012) and 0.6% over April. Strong vehicle sales helped, but total sales still rose 0.3% excluding vehicle sales. Considering that gas station sales fell 0.2%, the May total is very impressive.

The other good economic news released on Thursday was that new weekly jobless claims declined 12,000 to 334,000 in the latest week - the lowest level since early May, indicating fewer layoffs. The S&P's biggest daily gain last week was on Thursday (+1.5%), partly in response to this pair of positive reports.

On Friday, the economic news was more negative, causing the market to fall again. First, the University of Michigan/Reuters preliminary reading of consumer sentiment declined to 82.7 in June, down from 84.5 in May, while the consumer's view of "current conditions" fell to 92.1, down sharply from 98 in May.

Also on Friday, we learned that industrial production rose only 0.1% in May after falling the previous two months. Capacity utilization was just 77.6% in May, essentially flat with the 77.7% rate in April. Factory utilization is now at its lowest level since October 2012, when Hurricane Sandy disrupted the Northeast.

The other big news on Friday was that the International Monetary Fund [IMF] said in its annual review of member finances that the U.S. economic outlook appears "modestly tilted to the downside." Specifically, the IMF is only projecting 1.9% GDP growth for the U.S. in 2013, citing higher tax rates and the federal government's spending cuts as potential headwinds. Interestingly, the IMF said that there is no reason for the Fed to slow down its accommodative monetary policy and, when it does so, it should be done in a "gradual and orderly" way. Clearly, the IMF wants the Fed to keep pumping money into the economy.

50-word stock summary

"Now that the dollar is back on its long-term slippery slope, corporate profits should start to rise in the second half of 2013, as companies with global markets will be getting paid in appreciating currencies. As a result, the earnings growth rate for the S&P 500 should rise." - Louis Navellier

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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