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Weekly Market Update (August 03 - August 07, 2020)

By: Nela Richardson, Ph.D. August 07, 2020

Stocks extended the previous week's gains, while the Nasdaq set another record on better-than-expected economic data and improved trends in U.S. coronavirus cases. Business activity for the services sectors expanded, and the U.S. economy added 1.76 million jobs in July, beating estimates. The continuing, yet moderating, gains in employment show that the recovery in the labor market and the economy is on track, but there is still a long road ahead.

Dollar and Sense: What a Weakening U.S. Dollar Means for Investors

As seen in restaurants and retail stores across the country, change is hard to come by.  In fact, the U.S. is experiencing a coin shortage -- just another effect of the coronavirus pandemic that has reduced the number of coins in circulation due to dampened consumer spending and limited supply.  Coins are not the only form of U.S. currency currently under pressure. Though the U.S. dollar rallied a bit last week from the two-year low reached in late-July, the economic downturn, higher levels of government spending, and near-zero interest rates are likely to continue to push the dollar lower relative to a basket of global currencies.

A path of the U.S. dollar has a mixed effect on the economy. A weak dollar makes imported goods from other countries more expensive for U.S. consumers, but it also makes domestic exports more competitive abroad, which boosts profits for multinational U.S. firms.  With the U.S. dollar being the world's primary reserve currency, investors pay close attention to it because its path is a key driver of returns across financial markets, from stocks and bonds to commodities and precious metals.  Trends in the U.S. dollar also impact interest rates and inflation, shaping what investors can expect from asset returns in the future. Below we make sense of current trends in the dollar prompted by the unprecedented coronavirus and the impact of government stimulus measures aimed at reversing the worse economic downturn since the Great Depression.

  • Government stimulus aimed at strengthening the economy will likely weaken the dollar.

    Last week, even the stronger-than-expected July jobs report couldn’t alleviate market concern about a stalemate in Congress over providing another round of stimulus to combat the economic toll of the pandemic. The economy added 1.76 million jobs last month, chipping away at the record 20.2 million drop in jobs that were lost in March and April due to the lockdown of the global economy1. The July unemployment rate fell to 10.2% from 11.1% in June, and the underemployment rate, which includes part-time workers who would prefer to work full time, also improved moderately to 16.5% from 18%2.  

    Despite the better-than-expected report, the jobs market is still burdened by the abrupt shuttering of the U.S. economy. The unemployment rate has come down from the record high 14.7% reached in April, but it is still near the peak level of 10.6% reached during the Great Recession of 20082.  Moreover, due to measurement difficulties caused by ongoing local lockdowns, the unemployment rate is actually a percentage point higher than the official release, according to the Bureau of Labor Statistics, the agency that produces the monthly report.  With extended unemployment benefits having expired last month, and millions of U.S. workers still out of work, markets are closely watching whether Congress is able to put aside policy differences to provide a fresh round of stimulus to hard hit U.S. households in the form of direct payments, extended unemployment insurance benefits, and eviction moratoriums. Without this relief, there’s a concern that recent improvements in consumer spending may dwindle, slowing the economic recovery.

    The outlook of a slowed recovery timeline and the likelihood of more government stimulus and increased government debt have also contributed to a weakening of the U.S. dollar.  The dollar index, a measure of the U.S. dollar against a basket of currencies, fell 4% in July, the lowest monthly fall in over a decade2. Recently, real yields on 10-year Treasury bonds, which take inflation into account, dropped to the lowest level on record because of the prospect of rising inflation due to aggressive government stimulus and spending. Though inflation is likely to rise over time as the economy improves, we expect it to stay at moderate levels. Interest rates are also expected to remain at very low levels, which will likely keep the dollar trending lower for a while longer.
  • A weaker dollar can still pay off for a diversified portfolio.

    The dollar typically moves in multiyear cycles, rising against other currencies over long periods of time and then reversing for an extended period.  In 2009, in the aftermath of the Great Recession, the U.S. dollar reversed a period of decline by rallying 32% over an eight-year period, ending in 20172. In 2016, the Federal Reserve began increasing interest rates, while Europe and Japan cut rates lower in an attempt to boost their lagging economies.  Relatively higher interest rates increased foreign demand for U.S. government debt, which also increased the demand for dollars, leading to an appreciation. 

    After peaking in 2017, the path of the U.S. dollar was mostly flat prior to the global pandemic.  In March, in response to the unprecedented effect of COVID-19 on financial markets and the economy, the Federal Reserve cut the federal funds rate to near zero.  This action narrowed the differential between interest rates in the U.S. and other major economies, and put downward pressure on the dollar. A brightening outlook in Europe, which has seen success in containing the virus, may also reduce the dollar’s performance against the euro.

    A stronger U.S. dollar generally signals a strengthening U.S. economy, leading to higher U.S. stock returns.  On the flip side, a strong dollar can be a drag on international equity returns for U.S. investors. Over the long term, we believe that diversification across asset classes positively impacts investment performance while currency fluctuations have a muted impact on returns.
  • In the wake of COVID-19, gold prices shimmer but may dull over time.

    As the dollar slumped in July and August, gold rallied 17% reaching a record $2,063 before softening a tad to still lofty levels2.  Behind the gold rally was concern on the part of some investors that a large amount of government stimulus would cause a spike in inflation.  While gold has had periods of outperformance when inflation increased unexpectedly, it is also marked by extreme levels of volatility compared with other asset classes.  Moreover, gold has other characteristics that limit its value to long-term investors. It does not produce cash flow or dividends, it lacks an industrial usage like commodities, and its price is determined mainly by investor sentiment rather than fundamentals, making gold difficult to value. It’s likely that gold prices will continue to rise in the short run, but gold is less likely to provide the diversification benefit that other asset classes may help to provide investors over the longer term as the economy improves.  For these reasons, we recommend maintaining a small allocation (5% or less) in precious metals, including gold.

    Remember, in a year of unprecedented change, all that glitters isn’t always golden for investors. The key to making sense of the dollar’s path in an uncertain market environment is to focus on long-term drivers of equity returns – strong economic and corporate fundamentals.  While government stimulus can weaken the dollar, it also can foster better economic conditions, quicken the recovery for corporate earnings, and help provide a stronger backdrop for stocks to climb over time.

Nela Richardson, PhD
Investment Strategist

Sources: 1. Bureau of Labor and Statistics 2. FactSet

Index Close Week YTD
Dow Jones Industrial Average 27,433 3.8% -3.9%
S&P 500 Index 3,351 2.5% 3.7%
NASDAQ 11,011

2.5%

22.7%

MSCI EAFE 1,855.11 1.9% -8.9%
10-yr Treasury Yield 0.56% 0.0% -1.4%
Oil ($/bbl) $41.53 3.1% -32.0%

Bonds

$119.43 -0.1% 7.8%

Source: Morningstar, 08/07/2020. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.

The Week Ahead

The second-quarter earnings season will start to wind down with less than 3% of companies in the S&P 500 reporting results. Economic data being released in the U.S. include inflation on Wednesday and retail sales along with consumer sentiment on Friday.

Review last week's weekly market update.

Important Information

The Weekly Market Update is published every Friday, after market close.

Market indexes are unmanaged and cannot be invested into directly and are not meant to depict an actual investment.

Past performance does not guarantee future results.

Diversification does not guarantee a profit or protect against loss.

Systematic investing does not guarantee a profit or protect against loss. Investors should consider their willingness to keep investing when share prices are declining.

Dividends may be increased, decreased or eliminated at any time without notice.

Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal.

Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

The content of this report is for informational purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation. While the information is believed to be accurate, it is not guaranteed and is subject to change without notice.

The Dow Jones Indexes are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use.

All content of the Dow Jones Indexes © 2017 is proprietary to Dow Jones & Company, Inc.

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