Most of us know how hot August days begin in the Northeastern United States. A typical day starts with a cool mist and the promise of sun, but no warning of the humidity that will soon drop like a blanket as the sun burns through the early morning haze. Stocks feel a lot like that to me right now.
The current conditions are like an August morning, where things are still pleasant. But at some point, the heat will come to bear. Many markets are running hot -- above most fair-value measures. Combine that with a little "humidity" (i.e., liquidity concerns) and I think things will soon feel very uncomfortable on Wall Street.
When the sun ultimately comes out and the market realizes that stratospheric valuations are just that, the race for the exits might be intense as liquidity evaporates along with price support. But for now, the market's morning haze of complacency is masking the discomfort to come.
Yet while stocks remain complacent, foreign-exchange markets have already begun to swoon. The most notable characteristic there has been the U.S. dollar's prolonged weakness.
Many forex players are pontificating that the greenback has reached its weakest point in the cycle and is due to correct higher -- but I believe they're wrong. I think the dollar is weak because President Trump wants it to be weak. After all, a weak dollar is one policy that doesn't need court or congressional approval. Instead, Trump can orchestrate it simply through tweets, media interviews and tough trade talk.
Both the Bank for International Settlements and the International Monetary Fund recently speculated that the dollar is between 10% and 20% overvalued. So, I think the euro's recent move to 1.1750 against the greenback from 1.0400 isn't a cyclical top, but rather a base from where the greenback will likely drop even further.
Those calling for the dollar to form a base here need to expand their charts out from two years to 17 -- and take note of where the euro has traveled in its short life. Remember the euro's drop below 1.1500 against the dollar on the back of Greek financial woes and fear of a European banking contagion? Well that risk is now being taken out of the euro, as Greece is once again able to tap markets directly for funding. And as European fears subside, so does the "euro-vs.-the-dollar discount."
Of course, some market strategists love to point out that the European Central Bank won't be happy with a higher EURUSD. However, I'm afraid they forget that President Trump won't be happy with a lower EURUSD. And in a battle between the ECB and the White House, I think the United States will come out ahead. The ECB's thoughts on euro strength come in second to U.S. concerns about the dollar's overvaluation on the world stage.
The fact is that a stronger dollar worked perfectly over the past two decades for a U.S. economy that wanted to export Treasury bills. However, exporting T-bills doesn't provide jobs, nor does it pay taxes (as the current U.S. president is well aware).
By contrast, having the dollar weaken substantially vs. its peers for an extended period should attract manufacturing jobs to America -- and employed factory workers pay taxes (and often vote for the incumbent president).
I certainly believe that having 20 years of a stronger dollar (while every other country did whatever it could to weaken its own currency) resulted in U.S. manufacturing jobs going overseas. So, significantly weakening the dollar should see some of these jobs return, along with a rekindling of inflation that at some point would allow the Federal Reserve to normalize interest rates.
For all of the above reasons, I see further dollar weakness ahead. We're not at a low for the dollar -- instead, this is merely the beginning. And when the sun and humidity hit currency markets, the discomfort will be intense for forex traders. In fact, I believe a 1.25-to-1.30 EURUSD by year's end is entirely possible.