The US dollar (USD) has had a strong year against most of the world’s currencies. In this article we explain this movement and its impact on global stock markets. The rise of the USD has coincided with economic weakness in many foreign nations during a time when the US Federal Reserve has been raising interest rates, which in turn has boosted demand for US Treasuries. The US and the US currency However, recently the trade-weighted US dollar (against a basket of developed market currencies) has pulled back sharply due to results from the consumer price index and producer price index weaker than expected. This caused long-term US bond yields to fall and the US dollar with it. As shown in the DataGraph™ below, the US dollar is testing its 200-DMA, which has been above it since June 2021.
Daily Trade Weighted USD (vs. Euro, Pound, Yen, Franc, Krona, Australian Dollar), July 2021 – October 2022
Looking at a longer-term monthly DataGraph below, the US dollar has seen a substantial rise from its 2021 lows to its recent highs, appreciating roughly 28%. The short-term top of the dollar was confirmed by lower highs in October and early November, and then a sharp break below the 50-day DMA last week. Given the magnitude of the rally and the sharpness of the recent breakout, the greenback may be making a long-term top, although it has not broken above long-term support yet.
Monthly Trade Weighted USD (vs. Euro, Pound, Yen, Franc, Krona, Australian Dollar), 1993 – 2022
It is important to consider the effects that currencies have on global stock markets. Most of the USD bullish movement started in early 2022, which coincided with a spike in many global markets. Often, the strength of the US dollar results in relatively low performance from foreign equity markets, particularly emerging markets. This is compounded for US-based investors holding foreign funds, as USD-based ETFs are hurt by the rising dollar. The last multi-year period of US dollar weakness (2002-2007) coincided with strong global market outperformance (in USD terms) and was especially true of emerging markets. Therefore, the rising dollar helps the relative outperformance of the US stock market.
From year to date (YTD) and through the recent dollar spike, the damage to other currencies was widespread, as seen in the table below; some of the hardest hit lost between 8-20% YTD through September. The only major currencies relatively unscathed were the Brazilian real and the Mexican peso.
The combination of spikes in local stock markets in late 2021 followed by currency depreciation against the US dollar resulted in these foreign stock markets falling an average of 25% YTD through September in US dollar terms. The only markets (using popular ETFs as surrogates) that were not down at least 20% were Brazil, India, Mexico and Thailand, as shown in the table on the next page.
Select Non-US Global Stock Markets and Currency Exchange 12/31/2021 to 9/30/2022
However, the last six weeks have seen a big turnaround, with dollar-traded foreign market ETFs rallying sharply as underlying oversold equity markets and foreign currencies have strengthened.
Selected global currencies vs USD, 9/30/2022 to 11/17/2022
A good indicator of stock markets outside the US is the Vanguard Total Intl Stock Index ETF (VXUS
However, while VXUS has attempted to bottom out before on a relative basis, it has been unable to break the downtrend of more than a decade of lower Relative Strength (RS) lows against the S&P 500. While current ex-US ETFs. In existence prior to 2008, the last time global markets outperformed sustainably (more than 2-3 quarters) against the US, it was during the USD bear market and the general rally outside of the US. from 2002 to 2007 (see USD monthly chart above).
Vanguard Total International Stock Index ETF, December 2015 to September 2022
At this point, it is too soon to expect a repeated period of sustainable foreign market outperformance and US dollar weakness. In fact, global markets and foreign currencies still have a lot more to prove than the US market and the USD, which remains the long-term leader. At present, the odds are still stacked against the extended US dollar and underperforming stock market. But if we’re looking for ways to invest in that potential, we like international markets leading this short-term rally around the world. Specifically, these include Italy, Germany, France, Korea, South Africa, and Mexico. These markets have rallied 15-25% in US dollar terms over the last six weeks and are either above their 200 DMA or testing from below.
Performance of the Focus Foreign Markets ETF, January 2022 to November 2022
Some key themes that have helped foreign markets achieve near-term leadership include luxury goods in France and Italy; Industrialists in Germany and Korea; Banks and Real Estate in Mexico; and Retail in South Africa, among others.
Other markets to potentially consider include Japan, which has risen less recently but has ample room in terms of performance in the areas of the capital goods, consumer cyclical and technology sectors; India, which is also up less but is a long-term world leader with strong participation from the technology, basic materials, financial and consumer sectors; and China/Hong Kong, which has been in one of the most severe equity bear markets and for a much longer period than most. This market is beginning to show the emergence of new leadership in the Healthcare, Capital Goods and Consumer Cyclical sectors.
If there is a clear winner from the US dollar pullback, it is the global industrialists. The iShares Global Industrial (EXI) ETF, which seeks to track the S&P Global 1,200 industrial sector, is a great way to track the overall space. It has a 55% weight for the US market, but this is substantially less than the US weight for global indices with all sectors. Contains holdings from 18 countries with heavyweights in aerospace/defense, machinery, construction products, construction, subcontracting/staffing/market research, diversified operations, electrical equipment, pollution control, airlines, logistics, and shipping/rail. In the weekly DataGraph below, the strong relative performance over the past two months (coinciding with the US dollar high) is quite clear, with the RS line (vs. S&P 500) hitting a YTD high this month. The sector is well above its 40-WMA and close to a test of its August peak driven by strength in the US, UK, Japan, Germany and France, among others.
iShares Global Industrials ETF, December 2015 – September 2022
While we still recommend that investors have the majority of their capital investments in the US, we want to remain vigilant for a possible turnaround towards foreign markets. In this regard, we will closely monitor recent relative weakness in the US dollar and the stock market for signs that it is time to take more aggressive positions abroad. We’ll also be on the lookout for more clues as to what may join the industry as the next overall area of leadership.
Kenley Scott Directorresearch analyst William O’Neil + Co., Incorporated
As the firm’s global industry strategist, Kenley Scott brings his perspective to weekly industry highlights and writes global industry strategy, which highlights emerging industry and thematic strengths and weaknesses in 48 countries globally. He also covers the global energy, basic materials and transportation sectors and holds a Series 65 securities license.