Martin Enlund, Research Analyst at Nordea Markets, suggest that at an age of seven years, the upturn in the dollar has now lasted longer than the bull run in the eighties and in the nineties and if the dollar turns around, it will be a big deal for asset allocation.
Key Quotes
“Will US markets ever stop outperforming? Or rather, when? Those are two of the most important questions for asset allocators. Measured in dollars, the S&P500 has outperformed the EAFE (a developed market index) by roughly 100% since the end of the last US recession (in 2009).”
“Would a new US recession do the trick, and stop the relative outperformance of the S&P500?”
“Based on the past three or past five US recessions, we can conclude that a US recession is by itself not a reason to change asset allocation (US vs DM ROW).”
“The dollar usually gains during US recessions (when looking at the post-Bretton Woods era of floating exchange rates). Twelve months into a new US recession, the trade-weighted dollar has risen by an average of 6%, and by 10% two years after the onset of a recession. Only once, in 2001, was the dollar weaker (by 4%) after 24 months. Thus, a generally stronger dollar usually helps US markets outperform also in recessions.”
“Moreover, a stronger dollar generally tightens financial conditions outside of the US. This is counter-intuitive.”
“As the dollar tends to gain during US recessions, it not only underpins the return of the S&P500 but also weakens the return elsewhere due to a negative impact on activity. Hence the direction of dollar is quite important for asset allocation decisions.”
“The past two major bull moves of the dollar in the early eighties and the late nineties lasted for 6.4 and 6.8 years respectively. Measured by the trough to peak in the dollar, the S&P500 outperformed the MSCI EAFE index by 10% and by more than 100% in these two periods.”
“During the two periods where the dollar showed a long weakening trend, the S&P500 instead underperformed the MSCI EAFE index by 15% (1985 to 1995) and 25% (2002 to 2011).”
“At an age of seven years, the upturn in the dollar has now lasted longer than both the bull run in the eighties and in the nineties. Could it be getting old in its tooth? If the dollar has peaked or is about to peak, you are likely to get outperformance in assets outside of the US.”
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