In today’s Money Morning we take the plunge.
We ignore the consensus view and take the opposite side.
We put what little is left of our reputation on the line, and hesitantly make the case that the US dollar’s bull market days are numbered.
In fact, they might even be over.
The infamous magazine-cover indicator works pretty well
The Economist – which in my view would be better named The Dogmatist – had on its front cover last week an image of George Washington, his face as it appears on the US dollar bill, but with an extremely muscle-bound physique underneath. It ran the headline, “The Mighty Dollar”.
Such pronouncements often end badly. I know. I’ve made plenty of bad calls myself and attention-grabbing headlines often make the call look even worse.
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Among The Economist’s howlers was its “Drowning in oil” cover of February 1999. It came when oil was $12 a barrel. That was the last time oil was ever $12 a barrel. Next came a nine-year bull market that would take it up over 1,000% to $147.
Another belter was its 2009 “Brazil takes off” cover. It landed rather messily.
And who can forget it’s December 2012 effort: a stars-and-stripes convertible driving off a cliff, registration DEBT 1, with a drunk Uncle Sam at the wheel and a weed-smoking Statue of Liberty in the passenger seat. America – its currency, its stockmarket and its bond market – all did rather well after that, I remember.
In fact, a study of 44 Economist covers between 1998 and 2016 by Citibank analysts Greg Marks and Carl Donnelly found that “68.2% of covers are wrong after one year”. A market timer with a 68.2% success rate is about as a valuable a tool as you could hope for. Hedge funds would pay fortunes for it.
If a cover is very bearish, Marks and Donnelly found, and you buy, you’ll net an 18% return the following year; if the cover is bullish and you sell, the average gain is 7.5%.
Perhaps there’s truth to the saying that an “economist” is a trained professional paid to guess wrongly about the economy.
Marks and Donnelly conclude that “unequivocally hyperbolic covers of The Economist provide a strong contrarian signal… The next time you see The Economist playing up a market theme or saying XYZ is going to zero or infinity, be on high alert for a reversal… You now have solid empirical evidence that the hyperbole is probably a sign that the theme is nearly exhausted.”
Forget the Dogmatist – perhaps the Proctologist is better.
When he saw The Economist cover, my colleague Charlie Morris tweeted a photo with the words: “It’s official. The dollar has peaked”. He could well be right. The probability is 68.2%, it seems.
How many economists does it take to change a lightbulb? Seven (plus or minus ten).
So back to the dollar.
There are lots of good reasons to buy the dollar – so don’t
Bullish sentiment abounds.
The US Federal Reserve will raise interest rates this month – that will be dollar bullish. The US economy is strong; the pound is a disaster; the euro is falling apart; the yen is a basket case. The dollar has to go up – there’s nowhere else for it to go. It’s the only decent home in the neighbourhood.
Then there are Donald Trump’s new tax deals. Money held offshore by US corporations looking to minimise their tax bills will be repatriated. That spells billions of US dollar buying.
For sure, to be a dollar bear is a contrarian bet.
The arguments for it to rise are long and many. That is because the bull market is mature. The narrative has had many years to evolve. The bearish narrative, for that very same reason, is weaker. But that doesn’t mean it isn’t right.
Here’s a chart of the US dollar index, which measures the US dollar against a basket of foreign currencies, since 1980.
I have drawn the red band to illustrate an area of historical support, an amber band to mark historical resistance. That is the range we now seem to be in and we’re right at the top of it.
You can see the dollar enjoyed a huge spike from 1981-85, which was President Ronald Reagan’s first term. That rally ended with the Plaza Accord of 1985, when the governments of the five largest economies (except the Soviet Union), agreed to intervene in currency markets to depreciate the dollar.
There are many parallels between Trump and Reagan; perhaps this will be another. Perhaps the dollar is set to rally further, and The Economist is right.
Or perhaps the rally will peter out in the amber area line I have drawn in the chart above, and the dollar will then retreat.
My money is currently on the latter. My interpretation that the post-election break above 101 is a false one. Given that from false moves come fast moves in the opposite direction, I should know fairly soon if I’m right or wrong.
I’m not an economist, or a newsletter writer who has to keep peddling a particular market narrative. I’ve got my own money at the coalface – if you don’t mind me mixing my metaphors – and I need to be able to recognise when I’m wrong, so I’m always looking for signs of that. If it carries on rising, I’ll be stopped out and I’ll have to eat a bit of humble pie.
The euro was expected to plummet with the Italian referendum result. It started to, but then it reversed and it is currently higher than it was at Friday’s close. That strength is a bullish sign.
A weaker dollar would benefit Trump. It will make American exports more competitive, something he wants to see as he tries to boost US manufacturing. It might lure foreign investment capital from overseas. It will make his reflation and spending plan that much easier.
So I would imagine that steps will be taken to engineer US dollar weakness. A currency doesn’t always do what a country’s leader wants, but Trump is a man who habitually seems to get what he wants. Don’t bet against him.