Credit: Shutterstock photoAs U.S. markets enter the holiday season, the next few weeks is a time that is traditionally fairly quiet, with a focus on stocks, and a market that tends to trend in an upward direction. This year, however, could be extremely different, with stocks being driven by other, usually less-followed markets. Most people have seen days recently when stocks seem to be responding to movements in the price of oil, but many don’t take the necessary next step and ask what is driving the oil price.
Maybe it is the result of an arrogance born of nearly twenty years in the interbank forex market, but to me it seems clear that the biggest driver of that, and therefore of pretty much everything right now, is the value of the dollar. The big collapse in oil was, we are always told, the result of oversupply and worries about global demand. Yes, those factors undoubtedly played a part, but they were present when oil was trading above $100 per barrel. As the effects of that potential oversupply became clearer oil began to fall, but it is hard to believe that the drop would have been as spectacular if the dollar hadn’t started its rise at the same time.
To understand why, you have to understand the inverse relationship between the price of oil and the value of the dollar. Oil is priced in dollars, so, if the overall value of one dollar increases, the amount of oil that that dollar can buy goes up. Thus, the number of dollars needed to buy a fixed quantity of oil (one barrel) goes down, i.e. the price falls. Ultimately, because oil is priced in dollars, the value of the dollar is at least as influential on the price as the value of the oil itself.
The next question that one must ask, therefore, is what is driving the value of the dollar up. That is the result of two factors. Firstly, the Fed ended QE at about the same time as some other major powers embarked on or stepped up their own similar policies. In effect that meant that the supply of dollars was going down at the same time as the supply of other currencies, most notably the Euro and the Yen, were being increased. Simple supply and demand tells us that that puts upward pressure on the dollar.
It is, however, the second reason that the dollar has been so strong that should give stock investors pause. Like oil weakness, the dollar strength is at least in part driven by concerns about global growth. American assets are usually seen as a safe haven for global money, but that feeling has been exaggerated over the last year or so as it became clear that the U.S. economy was outperforming the other major economies in the world. You would think that that is a positive for U.S. stocks, but if the investment is in the nature of a flight to safety it indicates expectations of turbulence ahead.
I don’t want to be the party pooper spreading doom and gloom in the week when Americans get ready to focus on the positive and count their many blessings, but movements in global markets of all kinds indicate that the so called Santa Claus rally that we have come to expect at this time may be derailed this year due to outside influences. The rise in dollar index has stalled at around 100 and oil seems to have found a bottom just below $40, but if those levels are challenged in the next couple of weeks we will see a sharp correction in the stock market.
It is not that investors should be panicking; the overall trend of the U.S. economy is still positive after all. It is just that looking to trim some positions now rather than waiting until the end of the year could be a smart move, and on that somewhat gloomy note I would like to wish all U.S.-based readers a very happy Thanksgiving!
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
