Reason #1 For A Stock Market Crash – Dollar vs Foreign Currency

Bear market warning flags are waving rapidly these days.  There are numerous bear market signals and today I am going to focus on the dollar vs foreign currencies.

I call this Reason #1 but it does not mean this is the #1 reason why a stock market crash is looming.  I see many bear market warning signals and the dollar vs foreign currency is the first one I chose to talk about.

 

S&P 500 Recent Market Tops

Let’s first take a look at the S&P 500 over the last 25 years:

 

S&P 500 Last 25 Years

 

If you look at the 200 week moving average (red line) in 2000 and late 2007, you’ll notice the gap between it and the 50 week moving average (blue line).  We are seeing a similar picture today.

There are a couple reasons why we’ve seen the S&P 500 run up to new highs.  One reason is interest rates.  Not only in the US but around the world, interest rates are at the lowest levels in history.  In some countries interest rates are 0% or have negative interest rates.

When interests rates are so low, those who rely on yields from their savings account need a new place to put their money.  I saw this first hand when my Capital One 360 Savings (formerly ING) hit a high of 4.50% in 2006.  My savings interest rate has been 0.75% for the last few years now.

I experienced a savings yield decline of 83%!  For people who were relying on the yields from their savings, it no longer made sense to keep their money in savings.  The easiest move savers could make was to invest in dividend stocks which paid 2% or more annually.  This transfer of money from savings to the stock market has had an artificial impact on the stock market highs we are seeing today.

 

US Dollar vs Foreign Currencies

Along with low interest rates around the world we have also seen sluggish foreign currencies.  Let’s take a look at some major currencies of the world:

 

Dollar vs foreign Euro
The Euro has seen significant decline since 2014.

 

Dollar vs British Pound
The British Pound has been heading lower since 2014 despite BREXIT which added fuel to the fire.  However, we can see a bottom was forming in 2016 and laying the foundation for a rising pound.

 

Dollar vs foreign Canadian Dollar
The Canadian dollar has also been declining since 2013 however made a huge turn around at the beginning of 2016.

 

Dollar vs foreign Japanese Yen
The Japanese Yen shows the same story, decline in value since late 2012. Bottomed out in 2015 and started to rise again in early 2016.

 

We are starting to see the Euro, Canadian dollar and Yen moving higher in 2016.  The British Pound was also starting an ascent higher in 2016 but BREXIT put a stop to that.  That’s a unique situation and I feel the British pound would have continued to rise if BREXIT did not happen.

With interest rates and foreign currencies lower all around the world, the safest place for foreign investors to put their money was in the US stock market.  The US dollar was the only currency rising when all others were falling.

 

US Dollar and Stock Market in Decline

 

US Dollar Declining in 2016

 

 

In 2015, the US dollar topped out at the same level twice.  In 2016, the US dollar has started its descent.  The RSI, MACD and overall value are all declining.

A major reason for the US dollar declining is foreign money exiting the US stock market.  Foreign money came to the US because the currencies for foreign investors were going down in value and the US dollar was going up.  Foreign investors also invested in the US stock market because their stock markets were under performing and the US stock market was out performing their markets.

Foreign investors have profited in 2 ways by investing in the US Stock market.  First, they have profited on converting their declining currency into a rising US currency.  Second, the US stock market has been hot and out performing any other market in the world.

Now we are at one of the highest P/E’s in the S&P 500 over the history of the market at a 25 trailing P/E.  This is considered very expensive.  There are more reasonable valuations in the international markets abroad.

 

 

S&P 500 Historical P/E Ratio

 

From the historical P/E ratio chart of the S&P 500, you can see the P/E ratio rarely rises above 25, and when it does, the market ultimately crashes.

Now that the US market has become quite expensive and foreign currencies are trending higher, it’s time for foreign investors to pull their money out of the US.

I believe we are going to see a mass exodus of foreign money out of the US stock market.  Just as foreign investors profited twice by coming into the US market, they will lose twice if they don’t pull out now.

We see the first wave of foreign money exiting the US markets in 2016 as the US dollar has been floundering and trending lower.  The smart money has been exiting the US which includes hedge fund managers and large insurance companies.  The next wave of foreign money outflows will be happening soon.

 

Conclusion: Dollar vs Foreign Currencies

We can always tell when the market is high risk but it’s hard to know what will actually pop the bubble.  I feel the coming market crash will be a significant decline for three reasons:

  1. We have interest rates which have remained at historical lows.
  2. Money that would normally be in savings has been thrown into the stock market.
  3. Foreign investors bringing their money to the US due to their currency declining.

In the first chart of the S&P 500 over the last 25 years, you can see the two major tops prior to today’s market were right around the same level.  Today’s market has significantly surpassed the prior two tops due to these three factors.

The US dollar vs foreign currencies is one reason why I am not too interested in starting a dividend focused portfolio at this time.  My money will do better in ETF’s such as FXC and ULE.  When the market does start to tumble, I will have made money instead of losing money.  Then I can invest in a dividend minded portfolio.

 

Hi readers! What do you think about the US dollar vs foreign currency markets?  Do you think it will be a catalyst for a stock market crash?

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Cash Lab

Welcome to all aspiring early retirees! My wife and I still work however we have each been able to cut our hours worked from 40 each week to 24. We have had no change in lifestyle as a result (except more time with family) and are building wealth every month. I hope to share some of our ongoing story with you and be an inspiration to you on your path to financial freedom!

7 thoughts on “Reason #1 For A Stock Market Crash – Dollar vs Foreign Currency

  • Pingback: Trying to Tame My Honey Badger Style of Dividend Stock Investing

  • August 29, 2016 at 11:21 am
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    That’s funny you point that out about savings accounts producing lower yields so people moved their money into dividend stocks. That’s exactly what I did! I do think the market is topping out but it’s a hard decision to sell off my dividend stocks which took me so long to accumulate.

    Reply
    • August 29, 2016 at 11:26 am
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      Hi JP, yeah it’s definitely a different story if you already have a nice dividend portfolio built up. Since I don’t at the moment, I don’t feel it’s the best time for me to get started!

      Reply
  • August 29, 2016 at 6:20 pm
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    That’s a good analysis on currencies as they relate to the stock market. I never looked at currencies really or understood how they tie to the market. I would like to keep adding to my dividend positions even if a market drop happens. The rate of return is still higher than putting the money in savings.

    Reply
    • August 30, 2016 at 1:19 am
      Permalink

      I understand what you are saying. I look at stocks which are seemingly overvalued but they still have a dividend payout of 2-4% at high prices which beats any savings rate. I’ve been a trader for so long though that I would rather stay in cash and wait to buy low. I want stock price appreciation as well as dividend payouts. Thanks for stopping by!

      Reply
  • October 13, 2016 at 5:58 pm
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    So are you going to pull out of HR stock market and wait for a crash? I was thinking of moving to bonds but with a rate hike doesn’t seem the best either. May just keep it savings but I’m torn on staying in or pulling out and waiting for a big dip.

    Reply
    • October 13, 2016 at 6:59 pm
      Permalink

      I like cash the best but that’s not always an option with 401k accounts. So with our 401k’s I recently moved to short term US treasury securities as it was the best option. Even if there is no crash per se, I think a pullback is in order. I’m willing to wait for that with the market at its current levels!

      Reply

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