With the S&P 500 Index about to post its best quarter since 2009 and investor sentiment brightening, now may be a good time to look beyond stocks for profits.
Here’s a good place: the dollar. The greenback, as measured by the U.S. Dollar Index DXY, +0.26% looks poised to fall. So buying assets that benefit when the dollar sinks — gold, oil, energy stocks and commodities — makes sense. So does short-selling the dollar (betting on a decline), which you can do by purchasing the exchange traded funds (ETFs) named below.
Investing experts including Jeffrey Gundlach at DoubleLine Capital have been calling for dollar weakness since early September last year. The dollar has spent most of the time since then at higher levels. But now it looks like Gundlach may finally be right. Here are six reasons why, followed by 12 ways to play the trend.
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1. Trump wants a weaker dollar
One of President Donald Trump’s chief achievements has been to keep the Obama recovery intact. Positive employment trends — a core measure of economic strength — established by Obama’s policies have continued under Trump. Smoothed out averages of monthly jobs gains are roughly the same under both presidents.
Keeping the Obama rebound alive has allowed Trump to take credit for near-record low unemployment. Since this is one of Trump’s main themes with voters, he probably needs to maintain this trend to win in 2020. A weaker dollar will help. It increases demand for U.S. goods abroad because it makes U.S. goods look cheaper. This could support manufacturing job strength in key battle-ground states like Ohio and Wisconsin.
So it’s no wonder Trump has been calling for a weaker dollar. He said he opposes “a dollar that’s so strong that it makes it prohibitive for us to do business with other nations and take their business,” in a March 2 Conservative Political Action Conference (CPAC) speech.
2. Being long the dollar is a crowded trade
As president, Trump has a lot of power to sway policy in a way to get what he wants, a weaker dollar. So it’s a little surprising to see the growing bullish bet on the dollar. Speculators recently boosted their net long U.S. dollar position to nearly $30 billion, its highest level since late December, according to the U.S. Commodity Futures Trading Commission. That makes this bet a crowded trade, points out Larry McDonald of The Bear Traps Report, one reason he is bearish on the dollar.
What’s wrong with a crowded trade? In investing, it can be a bad idea to run with the crowd. Crowds often bunch up in asset classes around tops. This is why betting against the crowd as a contrarian often pays off. The big bullish bet on the dollar should trouble dollar bulls. But it probably doesn’t because human nature being what it is, a lot of people love company when investing.
3. Investors think U.S. inflation will heat up
Many analysts simplistically think interest-rate differentials alone explain currency moves, as money supposedly sloshes around the world chasing the best headline interest rates. But that is wrong. Money chases real interest rates, so you have to factor in inflation. When inflation is expected to heat up in a currency’s home economy, forward-thinking investors ease out of that currency because that inflation will erode its value.
It looks like this dynamic should start playing out with the dollar soon. Since January, inflation expectations embedded in Treasury Inflation-Protected Securities (TIPS) have picked up, points out Jim Paulsen, chief investment strategist at The Leuthold Group. This trend could hurt the dollar, sooner or later. Economists calculate embedded inflation expectations by subtracting the yield on 10-year TIPS from the yield on normal 10-year bonds. The difference increases as inflation expectations pick up.
4. Worries about geopolitical issues will calm down
When there’s trouble in the world, investors move to the dollar for safety. During the past several months two big geopolitical issues have haunted investors: Brexit and U.S.-China trade wars. These uncertainties have upped the bid for the dollar, says Paulsen. “If you resolve them, it is dollar-negative.”
A Brexit resolution would boost the British pound and the euro against the dollar. A resolution of the U.S.-China trade disputes would send investment dollars abroad from the U.S., since the resolution would dispel worries that trade wars will trim global growth.
Meanwhile, China and Europe are increasing economic stimulus to boost growth. If this works, it would draw investments abroad from the U.S. This would also weaken the dollar.
5. A declining dollar creates a feedback loop
Since commodities tend to go up in price when the dollar goes down, a weaker dollar helps emerging market (EM) economies, which are often commodity-based. That EM economic strength would weaken the dollar more because it draws investments out of the U.S. toward the EM growth.
6. Concerns about U.S. debt may heat up
During economic good times, politicians should take advantage of higher tax revenue to chip away at deficits and debt levels. Unfortunately, the ones we elected don’t understand this. Since Trump came into office, annual deficits and debt levels have arced upward, in a reasonably strong economy.
This is one reason why Bridgewater Associates’ Ray Dalio is bearish on the dollar. He fears the Federal Reserve may have to print money to fund the U.S. budget at some point because the sale of Treasuries won’t do the trick without substantially higher yields, which would hurt growth.
This may seem like an extreme view. But politicians on the left are now seriously thinking about printing money to fund government programs. They’re espousing “Modern Monetary Theory” (MMT), which holds that the U.S. can do this without any downside.
Grundlach describes MMT as “complete nonsense.” He’s equally harsh on Trump for the growing deficits and debt since the election — even though Trump promised he’d fight these, before he got elected. Trump’s loose fiscal policy is one reason why Gundlach is bearish on the dollar.
How to play a declining dollar
These ETFs go up when the dollar goes down: Invesco DB US Dollar Index Bearish Fund UDN, -0.41% ProFunds Falling U.S. Dollar Fund FDPIX, -0.37% and Rydex Weakening Dollar 2x Strategy Fund RYWDX, -0.78% These foreign currency funds would benefit: Invesco CurrencyShares Euro Currency Trust FXE, -0.23% and the WisdomTree Dreyfus Emerging Currency Fund CEW, -0.08%
Precious metals often go up when the dollar weakens so these ETFs could benefit: VanEck Vectors Gold Mining ETF GDX, -2.61% SPDR Gold Shares GLD, -1.42% and iShares Silver Trust SLV, -1.75%
Oil and energy names often do well when the dollar sinks, so consider these ETFs: SPDR S&P Oil & Gas Exploration & Production XOP, +0.59% and Energy Select Sector SPDR Fund XLE, +0.38%
Commodity prices and emerging markets could get a boost, so these ETFs may benefit: Invesco DB Commodity Index Tracking Fund DBC, -0.31% Vanguard FTSE Emerging Markets Index Fund VWO, +0.86% and iShares MSCI Emerging Markets EEM, +0.66%
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush is a Manhattan-based financial writer who publishes the stock newsletter, Brush Up on Stocks. Brush has covered business for the New York Times and The Economist Group, and he attended Columbia Business School in the Knight-Bagehot program.