By Mauldin Economics. Originally published at ValueWalk.
Inflation just keeps getting worse…
The cost of heating your home has doubled over the past year.
Want to take a summer vacation? That airfare will cost you 50% more than last year.
Whose fault is this?
It’s easy—and partially correct—to blame the US Government and the Fed. After all, they showered Americans with big stimulus checks and generous unemployment benefits, then held interest rates at zero.
But as I’ll show you in this essay… that’s an incomplete explanation.
The whole explanation is more important… and has to do with the quiet wrecking ball that’s battering the stock market.
US Dollar’s Purchasing Power
- Think $5 gas is bad?
Here in Ireland, gas prices just hit $8/gallon.
You see, devastating inflation isn’t just in America. It’s everywhere.
And inflation is worse in many countries than in the US.
That might sound hard to believe when you look at the US dollar’s purchasing power over time.
Look at this sad chart. It’s the US government’s own calculations of how much a dollar has been worth since 1980.
It’s been almost a straight line down for forty years.
Would you buy a stock if it had this chart? No chance.
- But at the exact same time… the “other” US dollar is rocketing higher!
It’s been a brutal few months for markets.
Stocks are having their worst start to a year since the 1930s. US government bonds are on track for their worst annual performance in over 200 years! Crypto has plunged.
But guess what’s hitting fresh 20-year highs?
The USD Index, which measures the US dollar against a basket of foreign currencies like the euro, Japanese yen, and British pound.
When this line is spiking, the US dollar is rapidly gaining value compared to other currencies.
At first glance, this is bizarre…
How can the dollars we spend daily be worth less than ever… while the USD Index soars to its highest levels since 2002?
It comes down to this: government currencies, including the dollar, are designed to lose value over time. When it comes to preserving your wealth, dollars are a horrible choice.
But all other currencies are even worse.
Although the dollar is falling in value, other currencies are falling even faster. So the USD Index is hitting multi-decade highs.
This might seem like nerdy macro “inside baseball” talk, but few things are more important than the strength of the USD index. A rising USD affects you, me, and every other investor in the world.
In fact, it’s driving much of the turbulence we’re seeing in markets right now.
- I call it the wrecking ball chart…
Each time the dollar spikes relative to other currencies, markets break.
Take another look at the USD Index over the past 25 years:
The dotcom bust… 2008… COVID…
It’s a “who’s who” of the worst market moments of the last 25 years.
And every single one was accompanied by a surging dollar.
Simply put, it’s tough for investors to make money when the dollar is surging past other currencies.
I could spend the next ten pages discussing why this is the case, but here are the cliff notes:
Just like your morning coffee and grocery bill is priced in dollars… so too is 90% of global trade.
Barrels of oil, copper wire, bars of gold, and tea leaves are all denominated in USD, no matter where they’re from.
When the dollar rises, it pushes up the cost of these items around the world. That means folks can afford less of them, which usually weighs on prices.
This is also true for financial assets like US stocks and crypto.
- What do Apple, McDonald’s, and Microsoft have in common?
S&P 500 companies get roughly 40% of their revenues from overseas. For example, Apple sells the iPhone across Europe. Folks pay in euros, and then Apple converts it back into USD.
When the dollar is on a tear, that revenue is worth less in dollar terms… which eats away at profits.
Apple, Facebook, Pfizer, Microsoft, McDonald’s, Salesforce, and a slew of other firms warned the strong dollar would cost them millions of dollars in lost profits this quarter.
- Watch the USD Index because it’s the wrecking ball chart…
Folks love to hate the dollar. We’ve been hearing about its flaws for decades.
But like it or not… the greenback is still the king of global currencies. We have to respect it. We have to understand it’s a lot harder to make money as an investor when the dollar is surging.
That’s why I’m watching for the strength in the dollar to ease up. That will likely be the first and most reliable sign that markets have found their footing and are close to bottoming out.
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Article By Stephen McBride, Mauldin Economics
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