Still All About The Dollar

Just going by the media headlines, you might think the stock market was the story of the week. Stock prices were down. Bonds, which apparently don’t have prices, just yields, which were up. Universal elementary commodities like gold and copper remained footnote decliners. The US dollar, meanwhile, rose only in terms of foreign currencies.

Veteran readers know Financology views this as a pile of incoherent hooey. The real story is much simpler: The US dollar increased in value. It therefore took fewer of them to buy all these other things … stocks, bonds, gold, copper, and foreign currencies. Another way of saying this is that prices (in USD) fell.

So while CNBC, Bloomberg, et al fret about losses in the stock market, we ask why not are they instead celebrating gains in the world’s most widely traded security?

That the dollar has begun to regain strength would seemingly be great news, especially considering that its decline is the single biggest economic problem facing Americans struggling to keep up with their cost of living, and one its issuer, the Federal Reserve, is most keenly focused on solving.

Meanwhile investors following the media must settle for being entertained instead of informed. The question of what’s going on with the stock market is a red herring … it hasn’t been doing much of anything. It’s still all about the dollar.

This is also a source of frustration at Financology, as we have been waiting for months for stocks to fall. Not merely in dollar terms, but relative to bonds and gold … and which fall remains elusive. Our thesis, informed by both fundamentals and technicals (eg SS), is that financial and economic developments should put unique pressure on stock values via corporate profits being squeezed between higher costs (especially labor, which sits at the end of the inflationary bucket brigade) and greater reluctance of buyers to pay for their products. This pressure has no effect on bonds, gold, copper, currencies, etcetera and so should result in a divergence between stocks and these latter others. While there is growing evidence that this is increasingly the case, it has yet to singularly affect stock prices.

In addition, the past couple years have left stock yields conspicuously out of whack with bond yields. (Yes, stocks have yields too!) The ten year treasury yield has roughly quadrupled from a range of around 0.50%-0.75% to 3.50%-4.25%. While non-US stocks are competitive in this latter area, the yield on the US stock market has risen only from about 1.3% to 1.6%. A much larger price decline would be required to produce a competitive yield increase.

We can only speculate as to why it has not yet occurred. The prevailing Wall Street media narrative has been that consumer price inflation will go quietly into the night and allow the Fed to stop tightening monetary policy and even begin easing. But the bond market is having none of it. And while stocks and bonds both have yields, the media remain largely silent about the former, maybe for fear that their audience might realize how out of whack they have grown and reprice stocks accordingly.

Both narratives present stock investors with a paradox. One is denial of the fundamental similarities between stocks and bonds, that they both have price and yield properties and compete for the same investor capital. The other is that the Federal Reserve has acknowledged that it needs financial conditions to tighten in order for its policy measures to be effective in quelling consumer inflation. So the very thing that would allow it to “pivot” itself turns heavily on a decline in stock prices. Whereas the very assumption that would allow stock prices to rise is a Fed “pivot”. 

So the pivot that would support rising stock prices depends on stock prices not rising. This is the grand Catch 22 facing stock bulls .., heads I win tails you lose.


6 thoughts on “Still All About The Dollar

  1. Bill Terrell says:

    Crude oil has been a notable exception to the pricing-unit-dominated environment. Every asset has its own supply-demand dynamics; it just so happens that the supply-demand dynamics for the dollar have dominated price action for most of them. The price of anything is a ratio of market values of both the asset in question and the asset it’s being compared with, and is a function of supply and demand for both.

    Oil prices have been notably driven by geopolitical factors and consumption patterns and while are also influenced by pricing unit fluctuation, the factors unique to oil supply and demand dynamics have dominated pricing.

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