Stock Market Highs And The U.S. Dollar
Summary
- Stock markets are at all-time highs.
- The US dollar is still the most important global currency.
- The Fed is keeping interest rates low and pursuing a dovish policy.
- Inflation is increasing.
- Dollar prospects are not particularly encouraging in an increasingly hostile geopolitical environment.
The purpose of this article is to consider how the present financial situation influences the US dollar so that investors can make decisions that affect the structure of their portfolios. The US dollar is the most important global currency and this helps to determine its value in Forex markets. At the same time, domestic developments are basic to determining the financial environment, and that includes the policies of the Fed as well as inflation.
All-Time Highs
US stocks markets are at all-time highs. People can be high thanks to drugs. The stock markets are high thanks to the Fed and inflation. This is widely known and has induced many to think that the stock markets will continue to have new highs continually. The Coronavirus did not stop the march northwards for the S&P, the Dow and NASDAQ.
There are differing views about how far the economy has recovered from the 2020 slowdown due to lockdowns. The extremely high stock valuations on the markets, however, are not an indication that the economy has not only recovered from the 2020 dip but has grown substantially. One indication that should make investors cautious is that the P/E ratio is also very high, namely, that the price for shares is high in relation to company earnings.
Price/Earnings Analysis Indicates Stock Market is Overvalued
Historically, P/E ratios were higher only before the Dotcom crash in 2000. Current P/E ratios are very high, and that means that investors are paying high prices for stocks. Given that prices are at extreme highs and P/E ratios are also very high, the prospects for the markets are not favourable. At the same time, one should take into consideration that the markets are signalling strong inflation with the high prices for investments in equities.
The US Dollar in Pole Position
The US dollar currently makes up about 59% of central bank reserves and is involved in over 80% of Forex transactions. Most of the global debt is dollar-denominated, and this will guarantee future demand for the greenback. One should also realize however that dollar dominance is not guaranteed for the future. The historical chart below shows that changes in the international financial world can occur. The Italians were at one point leading financial circles in the 13th to the 15th Centuries. The Portuguese real subsequently became the most important currency and then it was the turn of the Spanish real. In the 17th and 18th Centuries, the Dutch were leading merchants along with the French. After that, the British pound was dominant for over a century until it was overtaken by the US dollar, which has held its position to the present day. Whether Bitcoin will become a major reserve currency is not at all certain. In any case, it should be clear that the dollar is not destined to remain the primary global currency and change will come.
The Fed Forever
The Fed has made it clear that the accommodative policy of historically low interest rates with muted QE of $120 billion injected into the economy monthly in addition to a huge repo programme is not going to end any time soon. The fate of Japan will probably be replicated in the US where growth will be minimal despite huge amounts of stimulus and central bank purchasing of bonds. Obviously, the low-interest environment pushes investors towards the stock markets, and this will probably accelerate now that inflation has gained traction, thereby making fixed-income investments even less attractive.
Inflation Has Reared Its Ugly Head
Stock market prices are inflated. The prices of many other things have also increased markedly over the last year. That includes housing, rent, used cars, fuel and food. The FRED chart below shows that inflation is now officially 5%.
Prices for used cars indicate a higher inflation rate.
Market observers have filled pages and pages with statistics on inflation even if the Fed claims that inflation is transitory. What is exactly meant by transitory is open to various interpretations. It is highly likely that temporary means rather long term and not short term. The real problem, which has been seen by many, is that the Fed cannot raise interest rates to fight inflation without bringing on a severe recession or even something much worse. By keeping interest rates so low for so long, there is no easy exit and the Fed has not made known any exit plan.
Prospects for the Dollar
In making any prognostications for the health of the US dollar, all of the factors discussed above should be taken into account. There is also the fact that there are several countries that are not amenable to a continuation of US dollar supremacy. Afghanistan, China, Cuba, Iran, North Korea, Russia, Syria and Venezuela are not going to come to the rescue of the dollar if there are threats to the currently prime global currency. China’s digital yuan and IMF SDRs will erode greenback dominance. One can thus argue that the US dollar faces a hostile financial environment globally.
What is particularly discouraging is that the current American administration seems not to care about having an annual budget deficit of $ 3 trillion and a federal debt of over $28.6 trillion. This is not being financially responsible and could result in a loss of confidence in the US currency. This is so without even mentioning the $800 billion negative trade balance. Given the present situation, it is difficult to see the US dollar maintaining its value in Forex markets long term.
The fact that the stock markets have recently made tremendous gains is no guarantee that the highs are going to continue though inflation may help to keep the stakes high. The US economy has not yet fully recovered from the pandemic lockdowns even if inflated figures make it seem that the economy is growing. Investors should reckon with a tectonic shift in global finance, and that means diversification into foreign countries and currencies other than the US dollar would be a prudent policy to follow. The US Coast Guard motto “Semper Paratus” (always ready) and the boy scout motto “Be Prepared” can also serve investors.
This article was written by
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The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.
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Comments (17)
Quite right. Way back in the 13th, 14th and 15th Centuries there were city states like Venice and Florence along with other assorted principalities, kingdoms and the Papal State. The purpose of the brief note on the chart was to underline that the US dollar will probably suffer the same fate as other currencies. i.e., cease to be the most important means of exchange.
It is obvious that stock valuations are extremely high. Inflation has now become an important basic factor for investors, and we shall see how things work out with the current administration bent on continuing to spend very large amounts of money.
The purpose of the article was not to provide a history of Italy. The note on the chart was brief and intended only to show that the US dollar may suffer the same fate as other currencies in the past.
China is very far in advance of other countries in developing a digital currency that can be used as a means of exchange. PayPal and
Apple Pay are interesting as means of payment, but the digital yuan goes much further. The CCP is interested in being able to control and monitor financial exchanges, and this means that there is going to be regulatory interference with companies like Alibaba and Tencent.
One should not underestimate China. In 1976 when Mao died, China was one of the poorest countries in the world. In 2021, 45 years later, it is flexing its muscles and standing up to the US and successfully competing globally. The US had better get its act together if it is going to remain the prime superpower.
The US dollar has an important place in global finance thanks to the trust and faith that Americans and foreigners have in the greenback.The article tries to examine the connection between the stock market valuations and the factors that can influence the markets as well as the currency. The Fed's policy of practically almost zero interest rates and the continuation of what amounts to QE at the pace of $120 billion a month plus the repo programme that has reached record highs is basic to understanding the propensity of the economy to have higher inflation as well as to the value of the US dollar in Forex markets. The low interest rates should serve as a stimulus to the economy. One problem is that the Fed has no exit strategy in the case of increased inflation in that an increase in interest rates would most probably result in a severe recession and turbulence in financial markets even if the US dollar would appreciate in Forex markets. It will be interesting to see how things work out.
Thank you for the comment. We do live in interesting times, and, as Bob Dylan sang, "The times they are a'changin". China is close to overtaking the US as the biggest global economy and is working on a digital yuan. The Fed keeps on pumping stimulus into the economy while maintaining interest rates at extremely low levels. The administration has injected billions into the economy to help people out because of the "pandemic".
The Fed balance and the money supply have increased significantly. Even though the economy has recovered somewhat, the Fed and the administration keep on injecting money into the economy. Now we have inflation. So it looks like you are right about the bill coming due. We shall see what happens to the US dollar as the government continues making more and more debt.