DOLLAR INDEX HAS A STRONG WEEK AS EURO FALLS -- GLOBAL INVESTORS ARE FAVORING U.S. ASSETS -- STRONGER $ WEAKENS COMMODITIES -- AND FOREIGN STOCK ETFS

US DOLLAR INDEX TURNS UP... My Thursday message showed the Invesco US Dollar Index ETF (UUP) hitting a four month high and challenging its previous peak formed during October.  It cleared that barrier on Friday.   Chart 1, however, plots the US Dollar Index ($USD) which I prefer using to track the direction of the greenback.   Both measure the trend of the dollar against six major foreign currencies.  In order of their weighting in the two indexes, those six foreign currencies are the euro (57%), Japanese yen (13%), British Pound (12%), Canadian Dollar (9%), Swedish krona (4%) , and Swiss franc (3%).  All six have lost ground against the dollar since the start of the year.   The biggest losers have been the Canadian Dollar (-2.2%), the euro (-1.8%), the pound (-1.7%), the yen (-1.1%), the Swiss franc (-.8%) and the krona (-.2%).   As explained on Thursday, the currency with the biggest influence on the direction of the USD is the euro because of its 57% weight.   And it has fallen this past week to the lowest level in four months.

EURO BREAKS SUPPORT ON WEAK DATA... Stronger U.S. economic data this week (including Friday's strong jobs report) boosted the dollar.   While weak eurozone data hurt the euro.   Chart 2 shows the euro falling below its November low on Friday after a report that German industrial activity plunged 3.3% in December, while also falling in France and Spain.   All of the other currencies lost ground on Friday except for the Japanese yen which attracted some safe haven buying.   U.S. economic strength, combined with weaker foreign economies, is normally good for the dollar.

SIDE-EFFECTS OF STRONG DOLLAR... Thursday's message suggested three possible side-effects of a strong dollar.   One of them is that a stronger dollar usually signals that investors are turning back to the safety of U.S. stocks and bonds which increases the demand for dollars.  A second is a stronger dollar hurts the value of foreign stock ETFs that are quoted in dollars.   The third is that a rising dollar usually pushes commodity prices lower.   Let's start with the last one.

RISING DOLLAR PUSHES COMMODITY PRICES LOWER...One of the most consistent intermarket relationships is that the dollar and commodity prices usually trend in opposite directions.   Part of the reason for that is that commodities are priced in dollars.   So a rising dollar normally coincides with falling commodity prices.   Chart 3 shows that happening since the start of the year.  Notice the upturn in the U.S. Dollar Index (green arrow) in January coinciding with a downturn in the Reuters/Jefferies CRB Index of 19 commodities (brown arrow).  Most of the commodity losses were in energy prices and industrial metals (like copper) which have also been hurt by the coronavirus in China which has reduced demand for both economically-sensitive commodities.   And stocks tied to them.

As a corollary to that last point, the threat to global markets from the Chinese virus may be one of factors driving global money to the relative safety of the U.S. dollar along with Treasury bonds and stocks.  Which leads to our next chart.

U.S. STOCKS TAKE THE LEAD AGAIN... A rising dollar usually suggests that global investors are favoring U.S stocks and bonds over foreign markets.   A stronger dollar implies a stronger U.S. economy.  But foreign investors also have to buy dollars in order to invest in U.S. markets; which increases dollar demand.  So it's a circular pattern.  One way we can tell if that's happening is by using ratio analysis to compare how the U.S. is doing relative to foreign markets.

RATIO OF S&P 500 TO FOREIGN STOCKS IS RISING... The black line inChart 4 is a ratio of the S&P 500 divided by the MSCI All Country World Index ex US iShares (ACWX) compared to the daily bars in the U.S. Dollar Index (green bars).   And the chart shows a positive correlation between the two.  Dollar weakness during September and October caused the S&P 500 to lag behind foreign stocks.  Another dip in the ratio took place during December when the dollar weakened again.   Since the start of the new year, both have been trending higher together.   That means that U.S. stocks have resumed their role as world leaders.   And that's consistent with a stronger dollar.

RISING DOLLAR HURTS FOREIGN ETFS... The third side-effect of a rising dollar is that it reduces the value of foreign stock ETFs.  That's because foreign ETFs are quoted in dollars.   So when the dollar goes up relative to a foreign currency, the foreign ETF value goes down relative to its local market.   Shown below are two examples of that happening.

The red line in Chart 5 is a relative strength ratio of Canada iShares (EWC) divided by the Toronto Stock Index ($TSX).  The green bars show the trend of the Canadian Dollar ($CDW).  If you have trouble telling them apart, that's the point of the chart.   That's because they trend in the same direction.  Although the EWC plots Canadian stocks, it's denominated in stronger U.S. dollars.   While the TSX is quoted in weaker Canadian Dollars.   So the recent decline in the Canadian currency has caused its stock ETF to underperform its local stock benchmark.  That doesn't necessarily mean that the foreign ETF will decline in value.   But it will underform its local stock benchmark which is quoted in its weaker local currency.   As it's doing here.  That makes foreign ETFs less attractive to American investors.

FALLING EURO WEAKENS GERMANY ISHARES... The same currency relationship exists in Germany.  The green bars in Chart 6 show the euro peaking at the end of December (against the dollar), and falling during the new year to a four-month low.  The solid blue line is a ratio of Germany iShares (EWG) divided by the DAX Composite Index. There again, both are falling together.   Both German stock indexes have risen over the last month.  But the German DAX has risen +4.1% while the Germany iShares have gained +2.5%.   Most of that difference is explained by a -1.4% drop in the euro against the dollar.  In other words, the stock index quoted in the stronger dollar (EWG) has lagged behind the local stock index (DAX) quoted in a weaker euro.   That makes a difference to global investors.

INVESTORS ALSO BUY LOCAL CURRENCIES...  When American investors buy foreign stocks, they're also indirectly buying the foreign currencies. A falling foreign currency will detract from any gains made from its local stock market.   That's one reason why a rising dollar makes foreign stocks less attractive to Americans.  And U.S. stocks more attractive to foreigners.   The safest bet is to buy stocks in countries with rising currencies.   Right now, that favors the U.S.