PART THREE/ Trade And U.S. Dollar Sensitivity
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Posted On: 05/05/2017 3:16:46 PM
PART THREE/ Trade And U.S. Dollar Sensitivity
The greater U.S. focus for small caps should better insulate them against potential protectionist trade policy. The Russell 2000 generates approximately 20% of its revenue overseas, compared with about 35% for the large cap S&P 500.
Because of their greater U.S. focus, small cap stocks tend to do better in strong U.S. dollar environments. As shown in [Figure 3, bottom panel], small cap stocks and the U.S. dollar have mostly moved in the same direction in recent years (a positive correlation, shown in green, indicates that two variables move in the same direction; red indicates the two variables move in the opposite direction). The relationship has been particularly strong since Election Day, although some of the correlation may be spurious, i.e., driven by other factors. For example, small cap strength may have been driven more by prospects for a lower corporate tax rate than a strong dollar.
The U.S. dollar (based on the DXY Index, representing a basket of foreign currencies) is up 3.4% over the past three months and 4.9% over the past six months. From a technical perspective, the DXY Index has broken out of a decision box to the upside [Figure 3, top panel], suggesting a bullish long-term outlook. Fundamentally, we expect modest upward pressure on the greenback as the Fed hikes interest rates and inflation pushes longer-term rates higher.
The greater U.S. focus for small caps should better insulate them against potential protectionist trade policy. The Russell 2000 generates approximately 20% of its revenue overseas, compared with about 35% for the large cap S&P 500.
Because of their greater U.S. focus, small cap stocks tend to do better in strong U.S. dollar environments. As shown in [Figure 3, bottom panel], small cap stocks and the U.S. dollar have mostly moved in the same direction in recent years (a positive correlation, shown in green, indicates that two variables move in the same direction; red indicates the two variables move in the opposite direction). The relationship has been particularly strong since Election Day, although some of the correlation may be spurious, i.e., driven by other factors. For example, small cap strength may have been driven more by prospects for a lower corporate tax rate than a strong dollar.
The U.S. dollar (based on the DXY Index, representing a basket of foreign currencies) is up 3.4% over the past three months and 4.9% over the past six months. From a technical perspective, the DXY Index has broken out of a decision box to the upside [Figure 3, top panel], suggesting a bullish long-term outlook. Fundamentally, we expect modest upward pressure on the greenback as the Fed hikes interest rates and inflation pushes longer-term rates higher.
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