A lot of stock investors are like party goers on the deck of the Titanic. While the wine is flowing and the band is playing a loud music, everybody is having a great time, and it’s very easy to forget the greater world around you. It’s very easy to overlook danger signs that are in plain sight. In fact, even if the causal effect of one particular event plays out in front of you, and you actually feel the effect, there may be other things going on that throws you off from fully realizing the significance of the factors right in front of you. I don’t mean to sound vague but let me simplify it even further.
Investors should pay close attention to last quarter’s earnings reported by companies ranging from Caterpillar to Microsoft to Proctor and Gamble. All these companies took a hit due to the fact that the US dollar is so strong. While a lot of market observers would gladly dismiss this as simply another reflection of both the depressed price of oil as well as the quantitative easing happening in Japan and Europe, maybe a deeper look is warranted. If the US dollar is so strong, US economies will get hit so hard that it may have a domino effect to the rest of the US economy. This can lead to all sorts of unforeseen problems.
The last time the US dollar was this strong was in 2010, and it only lasted six months. We’re currently in the ninth month of US dollar appreciation and there is no end in sight.
What is the impact of the strong US dollar? It’s going to crash commodities’ prices, which can lead to a downward deflationary spiral. You have to understand that when it comes to economic damage, deflation is actually scarier than inflation. I know it seems rather counterintuitive because nobody’s a big fan of rising prices. However, when it comes to actual economic damage, decreasing prices pack a stronger and more lethal hit to the economy. If you need proof of this, just look at Japan and how it struggled since the late 1980s to get out of its deflationary hole.
Finally, the reason why the strong US dollar might be the black swan that finally craters and destroys the current stock market party is the sobering realization that it’s strong not because the US economy is strong but because other currencies are temporarily depressed due to quantitative easing. Put all these together and what we’re seeing is actually a veiled currency war. Just like with any currency war, there’s always bound to be an explosion.
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