The dollar has strongly increased in value because of a superior economic outlook, its role as the reserve currency and in anticipation of increased interest rates on the dollar.
While this was good for American purchasing power the strong dollar made exports less competitive while it made imports more compelling. This stopped the decline of the trade deficit while especially European countries rose to significant surpluses.
Even Italy which was known for its structural deficit has now a trade surplus
The reason the US recovered more quickly is partly because of quick economic stimulus but primarily because of a more flexible labor market. Which allowed the US economy to get rid of overcapacity more quickly while Europe had a classic double dip recession.
This however means that while the US labor market is getting tight the European economies can still expand by making unemployed labor more productive.
Flow of money
To keep its current valuation money has to keep flowing out of the euro and into the dollar to keep the valuation constant if for whatever reason this flow becomes smaller the value of the dollar will drop. While there is no current reason there are lots of potential reasons why this flow will dry up. The flow of money has pushed up the US stock market a lot more than its international counterparts.
This makes the US stock (NYSEARCA:SPY) market more expensive from a valuation perspective compared to the NIKKEI (OTC:NTKIF) and the stoxx 50 (NYSEARCA:FEZ). Especially when one values companies not on cyclical earnings but for example book value or sales.
Examples of different valuations are hard because the economic situation in countries is different, companies are not copies and time in the stock market cycle is different. An example of similar companies at different valuations however can be found here.
The US stock market has performed strongly as well as the dollar. This has made investing in the US popular but sustained popularity is needed for average returns. The trend of continued US outperformance can continue but is unlikely given the larger trade imbalances that will create which will require even larger outside investments into the US. Above average returns are made when being different from the crowd and being right. Investing outside the US is currently out of favor which makes most international equities undervalued relative to the US. A swing of the pendulum away from US investments would increase the value of foreign equity greatly!
Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.