The Dow Jones Industrial Average got an awakening this last week when two consecutive days of losses wiped out the year's gains. Down by 1.8% for 2018, it marked the worst half-year performance for the index since 2010.
Ironically, the losses were due to the strong U.S. economy and dollar, and the sluggish performance of overseas markets. More than half of the 30 companies that make up the DJIA receive 50% of more of their revenue from outside the U.S. By comparison, only 30% of the 500 companies that make up the Standard & Poors Index receive significant overseas revenue. The S&P 500 is still positive for 2018.¹
Since March 2009, when the U.S. pulled out from the bottom of the Great Recession, the domestic market benefited from one of the strongest rallies in history. The strength of the dollar increased in tandem. In order to thwart rampant inflation, the Federal Reserve Bank steadily raised interest rates. Chairman Jerome Powell recently raised interest rates for the second time this year, and indicated his intention to raise them two more times before the end of the year. Consequently, the dollar's value is at its highest since June 2017, compared to other global currencies -- up 5.5% against the Euro, and up 4.2% against the Japanese yen.¹
The dollar gained even more steam when mega-corporations were granted a "tax holiday" on profits held overseas in the latest tax law. $175 billion in profits were repatriated in the first quarter of 2018. Economists estimate that eventually, $450 billion will return to the U.S.¹
Emerging market countries, like Brazil, India, and Russia have been hammered by the strong dollar because in past years, they borrowed heavily in dollars to service their debt. Now, they have to repay the debt with dollars that cost even more. The Brazilian real is down 14% in value, the Indian rupee is down 7%, and the Russian ruble is down 9%.²
The firm dollar may be one of the reasons that Trump has decided to spark a trade war. Because the U.S. is in a stronger position than its global rivals, it may be hurt less than China or Europe, and can afford to "play chicken." The administration is even drafting a bill to exit from the World Trade Organization so it can impose tariffs with a freer hand, and without the consent of Congress.³
The tariffs have crippled markets outside the U.S. The Shanghai composite is in a bear market, down more than 20% from its 52-week high. The German DAX index is down 9% since January. The European market is down 6%, and Europe-focused funds lost $25 billion in assets in just the second quarter of the year. By comparison, U.S.-focused equity funds gained $3.2 billion in inflows in Q2. Of global investment portfolios, U.S. stocks and bonds now have a 60% share, the highest allocation since early 2017.⁴
U.S. Treasury bonds have also benefited from the turmoil. In a "flight to safety," investors have been drawn to the security of government bonds. The higher interest rates have made them even more attractive.
What does this mean for your personal investments? The money pouring into the U.S. market seems like a vote of confidence for strong, future growth. Because stocks are currently a little cheaper, this may be a buying opportunity. Volatility (the ups and downs of the market) may increase in the short-term because of the upcoming mid-term elections, and the continued uncertainty over how the trade war will play itself out. However, if you are investing to support 25 to 30 years of retirement, short-term volatility may be inconsequential to you.
The bottom line is, don't panic. This level of volatility is normal for the market, and is one of the reasons why the market holds out the potential for returns that are better than stashing money in a bank account. A strategy of broad, global diversification can be an effective way to reduce volatility, by spreading your risk. That way, no matter which of the many global markets is doing the best, your investment can benefit from it.
¹ Wall Street Journal, 7/2/2018
² Reuters 6/29/2018
³ Marketwatch 7/2/2018
⁴ Institute of International Finance 7/2/2018
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