Why The Dollar Will Continue To Surge, Crush Emerging Markets Stocks
The surge in the dollar isn’t over yet, and that means bad news for investors in emerging markets.
Beginning in late January the dollar index against major currencies has so far added more than 7% in value, according to government data. The move has come as the U.S. economy has accelerated while growth much of the developed world has remained sluggish.
A robust greenback is excellent for the U.S. economy because it attracts capital into the economy. More capital will result in yet more growth.
But at the same time, the strong dollar is a nightmare for emerging markets because investors take their capital away and send it to the U.S.
Emerging markets include lesser developed economies such as China, Russia, Brazil, and India.
The result of this change in the value of the dollar has been falling values for stocks in emerging markets. The Vanguard FTSE Emerging Markets ETF (VWO), which tracks a basket of emerging markets stocks, has lost more than 6% this year while the S&P 500 gained more than 5%, according to data from Yahoo Finance. The figures do not include dividends.
Unfortunately, for those invested in emerging markets the rally of the greenback is probably not over yet.
Friday morning we learned that U.S. growth in the second quarter hit 4.1%, according to the government’s first estimate. Meanwhile, growth in the single currency area of Europe, the so-called eurozone, has limped along at less than 1% for the last decade. The latest reading was a paltry 0.4%, according to data from Tradingeconomics.com that you can see here. Japan’s economy, the third largest in the world, is contracting, according to the latest reading.
That differential in growth, between the U.S. and other developed economies, should be enough to keep cash flowing into the U.S. and away from other economies.
“The number one reason to be long of the US Dollar is the rest of the world’s economies slowing,” says Keith McCullough, CEO, and founder, of financial research firm Hedgeye Risk Management. “We remain bearish on China, Europe, and Emerging Markets slowing in particular and see no reason why any trade and/or tariff deal will change that.”
In other words, the dollar will remain king for the foreseeable future, and that’s a good reason to buy greenbacks. Being “long” in investing terms means betting on a continued rally.
McCullough sees the dollar index possibly surging without hindrance to 103 from its current rate around 91 recently.
If that continued rally happens then, emerging markets will take yet another beating.
The pummeling likely won’t be limited to stocks. Emerging markets bonds have also spent the year so far sliding. The iShares JP Morgan USD Emerging Markets Bond ETF (EMB) which tracks a basket of bonds from emerging markets economies, has fallen by around 6% since the beginning of the year.
The beaten down prices of securities in these markets may mean its time to start looking for bargains. However, investors should be wary because it is always extra tricky and financially dangerous to step into markets that are falling.