With US stocks up for the fourth straight day and now positive for 2016, more investors are calling it a long-term reversal and not just a bounce within a bear market. Some say it’s because crude oil is up and the Hong Kong stock market is up after months of trouble in Chinese equities. But it’s also because bonds have fallen and the dollar has surged. Here’s the connection.
By Vikram Rangala
Monday, March 21, 2016
US stock markets were quiet Monday morning, but holding onto last week’s impressive gains, which finally took the equities into positive territory for the year. The first quarter was marked by talk of a bear market that might extend through the rest of the year. Some are still bearish, expecting stocks to give back their gains at the first sign of weakness in crude oil prices. But others see more reason to call this the start of a major rally.
Crude oil futures, both the Brent and West Texas Intermediate varieties, are now above $41 a barrel. This recovery erases the losses since January, when crude began its slide to 12-month lows in February. One obvious factor is the expected disappearance of some US shale oil producers, who could not survive extended low prices.
The other factor commonly blamed for investor bearishness, China, has a strong positive in the 13% rise in the Hong Kong stock index. China’s Hang Seng was last year’s worst performer among developed-nation stock markets, with panic in Chinese equities sending ripples around the globe. The sectors which led the drop also have put in the strongest showing in the rebound.
When investors were selling stocks last year and into the first quarter of this one, they shifted their money into the so-called safe havens of gold and bonds, particularly US Treasury bonds and notes. That demand drove 10-year yields toward record lows in February, meaning bond futures soared. Gold closed down for the second session in a row as well.
It’s only a slight oversimplification to say that the money that was pulled out of stocks and put into the safe havens is now going the other way, back into US equities. The Fed’s cautiously optimistic statement last Wednesday, combined US GDP and job growth, has many investors viewing US equities once again as the best place to risk their capital.
One factor ties all of the others together: crude oil, bonds, US exports, and even the containment of any further ripple effect from China. That is the long-awaited drop in the US dollar, whose strength had gone from insurance policy for a troubled global economy to a growing nuisance.
The dollar’s strength had become a problem, but as it trends down, it allows some other beneficial things to happen. For example, the ICE U.S. dollar index, which measures the USD against a basket of six currencies, fell to its lowest level of 2016 last Thursday. A weak dollar makes it easier for U.S. companies to turn a profit, particularly those which rely on exports. This in turn has a larger effect on GDP and job growth.
A weaker dollar also means that crude oil — which is priced in dollars — becomes more affordable to buyers who use other currencies. This helps push crude prices higher by increasing demand. At the same time, those individual consumers, facing lower fuel costs, have cash to spare to buy products and services including those produced by US companies.
Finally, as the dollar continues to weaken, it will allow the excess holdings by major dealers in US Treasuries to gradually find buyers, freeing up cash for more lending and investment. The strong dollar has served the world well and is now politely stepping aside, hopefully to give way to real growth in GDP and wages.
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