Excerpted from the April issue of the Provident Investment Management newsletter.
With the dollar rallying sharply against the euro, U.S. investors might want to spend some vacation days — and dollars — on the Continent this summer. $1 buys €0.95 right now, up from €0.88 one month ago. Last year at this time, $1 was worth €0.71. The American traveler has effectively become 34% richer in euros. The dollar has also appreciated 21% in Japanese yen and 13% in British pounds.
The S&P 500 has fallen 1.5% since mid-February. According to finviz.com, seven of the market’s nine sectors are down over the past month. Only one, health care, is up more than 1%. The basic materials sector has been the weakest performer, down 9%, as numerous commodities are down sharply in dollar terms. Oil has fallen about 10% over the past month. Gold is down 4%. It is no surprise to see global commodity prices declining, but the magnitude of the decrease is a little startling, especially for oil. Russia and Brazil both rely heavily on oil exports and both have seen their currencies fall by more than half compared with the dollar.
Currency weighs on the U.S. stock market in numerous ways. Overseas profits for American multinationals translate into fewer U.S. dollars on the income statement. There is also the issue of competitiveness. An American exporter with a U.S. supply chain will either lose market share against foreign competitors or be forced to accept lower margins. It takes time for exports to adjust to currency fluctuations, so we expect continuing headwinds for exporters.
On top of currency, there are two other caution signs for the U.S. stock market right now. After a strong 2014, utilities stocks are 2015’s worst performing sector so far, down 6% on a year-to-date basis. Utilities are very sensitive to interest rates, and their weakness could signal that investors expect higher rates to come.
Interest rates for two-, five-, 10-, and 30-year Treasuries are all basically flat compared with one month ago. The only part of the curve which has changed during the past month is the very front end, where 6-month yields have increased from an annualized 0.06% to 0.13%. Technically, that’s more than a doubling within one month, but practically speaking, short-term interest rates remain at zero. The Federal Reserve should bump up short-term rates later this year. The long end of the curve is controlled by market forces rather than Fed policy, so there is no guarantee it will move in step when short term rates finally rise.