The Black Swan in Plain Sight: King Dollar
Nassim Taleb has written about three key attributes used to identify a Black Swan:
“First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility.
Second, it carries an extreme impact.
Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.”
Let’s go through each of these factors in evaluating whether the recent move in the U.S. Dollar qualifies.
1) An outlier
If the Dollar Index finishes higher in March, it will be up 9 consecutive months, extending what is already the longest streak in history.
In the past 30 years, this is the largest 9-month advance in history, surpassing the spike in 2008-09.
By any objective measure, this is an outlier.
2) Carries an extreme impact
The impact of this extreme move higher in the world’s reserve currency cannot be overstated.
Commodities prices are trading at 12-year lows.
Crude Oil has dropped nearly 60% in the past 9 months, one of its largest declines in history.
The Dollar’s rise is already starting to hit S&P 500 earnings which declined 14% in the 4th quarter. This was the worst decline in earnings during the expansion that began in June 2009.
The Dollar’s advance is also hurting companies in emerging markets which are facing significantly higher costs on trillions of dollar-denominated debt. Historically, we have seen higher default rates in emerging markets during periods of dollar strength.
While Japan and Europe are debasing their currencies to boost exports, I have argued that it is a zero-sum game and their growth must come at someone else’s expense. On this point, we are seeing U.S. exports down 5% over the past year to their lowest level since 2009.
Given these factors, it is hard to argue that the Dollar strength is not having an “extreme impact.”
3) Explanations for its occurrence after the fact
If you’ve been listening to the financial media of late, it seems as if the Dollar’s advance was entirely explainable and predictable. Europe, Japan, Australia, Canada, China and more are still easing monetary policy while the U.S. is expected to change course in a few months. Surely everyone knew this a year ago and should not be surprised by what has transpired.
In reality, though, few could have envisioned the broad-based declines in nearly every currency in the world against the U.S. Dollar. Of the G-20 countries, the Saudi Riyal is the only currency holding its own against the Dollar in the past year and that’s only because it is pegged to the Dollar.
To have predicted the Dollar’s advance against all of these currencies a year ago is to have predicted negative interest rates across Europe, a 60% decline in Crude, an increase in Japanese quantitative easing, the announcement of quantitative easing in Europe, a collapsing Ruble/Real, and more. This was unlikely feat to say the least.
As Taleb has written, it is human nature for us to “concoct explanations for its occurrence after the fact,” but that doesn’t mean it was actually predictable.
The Black Swan in Plain Sight
Based on Taleb’s criteria, it would seem that the Dollar’s advance over the past nine months would qualify as a Black Swan event. If King Dollar is indeed a Black Swan, though, why haven’t we seen reverberations in the U.S. equity market? Probably because it has not yet been elevated to that status among the consensus. Similar to how stocks ignored the initial decline in housing in 2006-07, the stock market is dismissing the abnormal strength in the Dollar.
The bullish narrative that has supported shares has been that a strong dollar is a positive because it means U.S. growth is booming. A quick examination of the facts, though, dispels this notion as U.S. real GDP growth in this expansion continues at its slowest pace in history.
The truth is that the Dollar is strong this time around not because the U.S. economy is booming but because Europe and Japan (the largest components of the Dollar Index) are intent on crashing their currencies. For now, many still seem to believe this debasement and global currency war is a rising tide that lifts all boats, but should weakness in U.S. macro data and earnings continue, this belief may be tested.
With extreme volatility in currencies, commodities, and bonds, it would seem to be only a matter of time before we witness a spillover to equities. And with the Dollar’s black swan advance occurring before the Fed has even removed the word “patient,” we can only imagine what volatility will ensue when they actually raise rates.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
CHARLIE BILELLO, CMT
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
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