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Equities

What does a strong dollar mean for the relative performance of US equities?

The real theme of the past year or so has been the continued strengthening of the US dollar against most other DM currencies. A pattern we've seen quite consistently, historically, is that when the US dollar strengthens, US equities tend to do better relative to their peers elsewhere. It's not just the fact that it's boosting the returns in comparable currency terms but because a stronger dollar is associated with a stronger US economy and more optimism about its stock market for that reason. And that chimes with what we've seen of late: even if the economic outlook in the US isn’t great in absolute terms, it's looking good in relative terms. This framework for the dollar leads into what we're thinking over the near-term, where we think the US dollar has further to strengthen, partly because we think the economic outlook in the US looking better than elsewhere but we suspect that mid-to-late next year we're going to start to see the global economy starting to turn a bit of a corner. We think the Fed may consider cutting interest rates quite aggressively and also, by that point, we think the economic outlook in Europe will start to look rosier and that could result in a sharp turn in the dollar. So if we read across from that move in the dollar to moves in relative economic performance to moves in relative stock market performance, we think that at some point next year we could see a cyclical turning point that would see stocks in the rest of the world starting to outperform the US. Now, relative valuations don't necessarily tell us much about performance over the next couple of years but we think they tell you something about the longer time horizons and, in those terms, the valuations gap that has opened up between the US and elsewhere could work in favour of non-US stocks.