Impact of the U.S. Dollar Decline on Investments

The U.S. dollar has been on a downtrend, and if this trend continues, investors may find “better things to own than Nvidia,” according to Gavekal Research in a report released Monday.

Gavekal highlights that a weaker dollar could fundamentally alter the investment landscape, posing a challenge to the dominance of popular U.S. tech stocks, particularly Nvidia (NASDAQ:NVDA).

Historically, the strength of the U.S. dollar has been a significant factor attracting capital to U.S. equities. However, with the Federal Reserve hinting at a more dovish stance and potential interest rate cuts, the dollar’s appeal may diminish.

The firm explains, “The shift in U.S. monetary policy is bearish for the U.S. dollar,” which may lead to a reallocation of global capital.

Gavekal presents three potential scenarios regarding the dollar’s performance and its effects on equity markets:

1. Policy Attempts to Weaken the Dollar: In this scenario, U.S. policymakers fail to weaken the dollar. As a result, the U.S. remains the “cleanest dirty shirt” in the global economy, leading to continued capital inflow into U.S. stocks, with Nvidia and its peers sustaining strong performance.

2. Weaker Dollar Fuels Corporate Profitability: This scenario suggests that a weaker dollar could enhance the profitability of U.S. corporations, breaking the historical correlation between dollar strength and U.S. equity strength. The report states, “US equities continue to do fine, even as the US dollar weakens.”

3. Continued Dollar Decline: The third and most crucial scenario highlights a continued decline of the dollar, which could drive capital toward international markets. In this case, investors might seek better options than high-valuation stocks like Nvidia, especially if the dollar depreciates by around 5% annually. Gavekal emphasizes that if the U.S. dollar loses 5% each year, there are more appealing investments than Nvidia at 75 times earnings or Microsoft (NASDAQ:MSFT) at 35 times.

The current market reaction to Federal Reserve Chairman Jerome Powell’s speech seems to lie somewhere between scenarios two and three. Following Powell’s remarks, the dollar dropped significantly, commodities surged, and equity markets rallied, reflecting some alignment with the second scenario. However, the outperformance of the Russell 2000 over the NASDAQ Composite and the stronger performance of energy stocks compared to technology hints at the possibility of the third scenario taking precedence.

If the dollar continues to decline in the upcoming days, Gavekal strategists believe that the third scenario is likely to unfold.