- Ray Dalio believes the U.S. dollar could soon decline amid escalating trade tensions with China.
- Historical data shows the U.S. stock market performs poorly when the dollar enters a downtrend.
- The Federal Reserve is the crucial variable that could prevent another market downturn.
Bridgewater Associates founder and billionaire investor Ray Dalio believes the U.S. dollar will soon decline. Historical data suggests the U.S. stock market could fall in tandem.
As geopolitical risks intensified from worsening U.S.-China relations, an increasing number of investors have flocked to haven assets. Gold has surged by 8.3% since July 16.
If the Dollar Drops, Stocks Could Become Vulnerable
Speaking on Fox’s Sunday Futures, Dalio said a capital war between the U.S. and China could be next.
The investor emphasized that a trade, technology, and geopolitical war is ongoing. If a capital war is next, he said the U.S. dollar could continue to decline.
In the past three months, the greenback has underperformed against major reserve currencies.
The things I worry about the most are the soundness of our money. You can’t continue to run deficits, sell debt, or print money rather than be productive and sustain that over a period of time. If we don’t work together to do the sound things, to be productive, to earn more than we spend, to build the stability of our currency and build the balance sheet, we are going to decline.
Mitul Kotecha, a senior emerging markets strategist at TD Securities, also said the dollar is at risk from various threats:
Historically, the U.S. stock market has performed significantly better when the U.S. dollar is strong.
Data from FactSet shows that the U.S. dollar index fell 34% from 2002 to 2007. During the five years, U.S. equities underperformed global stocks.
With the dollar index up 24% since 2011, U.S. equities have massively outperformed foreign stocks.
Since 2011, the S&P 500 ETF trust climbed by more than 13%. In contrast, the MSCI ETF, which tracks global equities, rose by just over 5%.
One Variable That Could Prevent a Simultaneous Decline in Stocks and USD
According to Morgan Stanley strategists, the August FOMC meeting could fuel market sentiment.
Strategists anticipate that the Federal Reserve will keep rates low throughout 2020. Relaxed financial conditions could reduce selling pressure in the market and drive appetite for risk assets.
Morgan Stanley’s Matthew Hornbach wrote:
The July FOMC meeting should kick off a period from August into mid-September in which markets should price in an increasingly dovish, forward-looking Fed policy via lower real rates. This should benefit breakeven inflation rates, support risk assets, and weigh on the U.S. dollar.
If the FOMC meeting coincides with calming U.S.-China relations, it might be a catalyst for equities in the fourth quarter.
The U.S. government is also planning to release a $1 trillion relief package on July 27.
Stimulus and Fed liquidity have fueled the appetite for stocks since the pandemic began. As long as the Fed balance sheet does not massively contract and liquidity remains high, analysts remain neutral entering the fourth quarter.