The US Dollar Index is up over 6% this year, almost all attributable to a post-election surge. As many developed nations show stagnant economic growth or even contraction, the U.S. economy continues to hum. Further bolstering the dollar is the likelihood that the Fed will slow rate cuts or stop them after this Wednesday’s FOMC meeting.
Consequently, the Fed is considered more hawkish than other large central banks. Wall Street thinks the dollar will peak and decline in 2025 despite its current strength and economic backdrop. The following is from a Bloomberg article:
From Morgan Stanley to JPMorgan Chase, roughly a half dozen sell-side strategists, are now forecasting the world’s reserve currency will peak as early as mid-next year before starting to decline, with Societe Generale) seeing the ICE US Dollar Index falling 6% at the end of next year.
So, if Wall Street proves correct, what might that portend for domestic/global stock allocations? To help answer that question, we lean on recent research from Crescat and their telling graph below. It shows a robust correlation between the dollar index and the relative returns of the S&P 500 versus global (non-U.S.) stocks. Per Crescat:
“Both lines now appear to be reversing direction, which may indicate a potential shift in the dollar’s trend.”
We see little to suggest that the dollar’s long-term relative strength is reversing. However, that opinion could change with a recession. Moreover, adding exposure to non-U.S. stocks may prove fruitful if the dollar strength reverses with economic weakness.
What To Watch Today
Earnings
- No notable earnings releases today.
Economy
Market Trading Update
Yesterday, we noted that we are approaching the end of the December portfolio rebalancing and distribution period. While the market could be volatile ahead of the Fed meeting on Wednesday, the market should be in a good position to rally into year-end as corporations complete buybacks and managers “window dress” portfolios. One thing to be wary of heading into next year is the very low volatility index readings, which are generally a warning sign preceding short-term corrections and consolidations.
A current-level reversal would be unsurprising, given that VIX is trading well below its 50-DMA and is decently oversold on a relative strength basis. This is particularly the case given the very high levels of complacency among investors and exceedingly cheap hedging costs, which implies little concern about a near-term correction. While we don’t expect such a correction before year-end, a post-inauguration pullback would align with historical tendencies.
For now, we suggest maintaining allocations to equities for the year-end push. Once the new year is underway we will evaluate current conditions and begin to make recommendations for rebalancing and risk mitigation.
Yesterday’s interesting note was that MicroStrategy (NASDAQ:MSTR) would be added to the Nasdaq 100 index. The “curse” of index additions has often plagued stocks, with the stocks leaving the index often performing far better. A recent example was Super Micro Computer (NASDAQ:SMCI), which was added to the S&P 500 just before it was corrected by more than 60%. The people behind the index are often plagued by the same “emotional” biases as investors, and they tend to add stocks to the index during a period of FOMO.
This is why it has often led to disappointing outcomes for the additions and better outcomes for the deletions. Nonetheless, this will be an interesting thing to watch in 2025.
Interesting Commentary From Our Next (LON:NXT) Treasury Secretary
We just stumbled across a speech from Treasury Secretary appointee Scott Bissent. Six months ago, at a speech given to the Manhattan Institute, he stated the following:
“We’re also at a unique moment geopolitically, and I could see in the next few years that we are going to have to have some kind of a grand global economic reordering, something on the equivalent of a new Bretton Woods or if you want to go back like something back to the steel agreements or the Treaty of Versailles, there’s a very good chance that we are going to have to have that over the next four years and I’d like to be a part of it.”
Bretton Woods saw the establishment of the dollar as the world’s reserve currency. Something of that magnitude would have massive impacts on U.S. and global asset markets. It will be worthwhile to pay attention to Bissent’s speeches over the coming year to see if he alludes more to his vision.
DIY Research – Factors
The Simplevisor factor analysis below shows that most market factors have overbought absolute scores, denoting a bullish stance. However, on a relative basis, only five are overbought compared to the S&P 500. This week’s analysis shows a hint of what predominated in the first half of the year—large mega-cap stocks leading the way, while value and small caps underperformed.
Given the significant rebalancing needs for large and small investors, this condition could fade as quickly as it arose. Next week, we may find that value and small caps are in favor while the large-cap stocks fade.
Kathy Wood’s ARK Innovation ETF (NYSE:ARKK) has been overbought for a few weeks. This comes after a prolonged period of underperformance. In early June, the ETF was flat to lower for the year to date; all the while, the broader markets were up over 20%.
In just over a month, the fund has risen by over 20% and largely caught up with the S&P 500. Helping the outperformance is its 15%+ weighting to Tesla (NASDAQ:TSLA), which has increased by nearly 70% since early November.
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