Is a Sagging USD Bad for Stocks? Don't Bet Your Bottom Dollar on It

While it is almost impossible to take your eyes off the meteoric rise of Tesla , Apple and a handful of other names, the weakness of the dollar is attracting attention. In the past three months, the dollar has given up most of the gains that it took over two years to accumulate. The move has been rapid. So far, the dollar weakness has been great for stocks: Dollar weakness makes U.S. stocks cheaper on a relative basis for foreign buyers. With roughly half of sales in the S&P 500 occurring outside the U.S., the weaker dollar lets any profits overseas be translated back to much higher profits in dollars. At some point, the weak dollar might pose problems.There are benefits to being the world's reserve currency and it could affect how we compete with China globally. At some point foreign investors might be afraid enough of a falling dollar that they sell U.S. stocks and bonds. That isn't happening yet, and timing that inflection point is more art than science, but is something bond and stock investors need to watch closely. Fed Policy & the Weaker Dollar Over the past few months, inflation risk is something that has popped up on the radar screen with more regularity than any time in the past few years. I do see some risk of inflation, largely driven by shifts in the global supply chain, where we could see more production returned to the U.S. and other higher cost countries, or more effort will be focused on ensuring suppliers from other countries place more emphasis on quality and worker care. I expect inflation risk to show up in a weaker dollar, not higher yields, and here's why: The Fed is committed to keeping short-term rates, which are controlled via Fed funds, very low. The Fed will also continue to buy Treasuries to stabilize liquidity in that market. Finally, the Fed will discuss some form of yield-curve control (setting target yields on treasuries out the curve), which will restrain the ability for yields to go higher. So, inflation risk, which would normally express itself in higher yields, needs to get expressed elsewhere. It is like trying to hold down a balloon, when you push the air out of one end, it goes somewhere else. So with rates controlled by Fed policy, inflation risk will show up as a lower dollar. The real yield -- the interest rate earned above the rate of inflation -- is negative 1%. It had been declining for a number of years, but is now lower than at any time in the past two decades. Higher Yields: The Greatest Risk to the Stock Market I do believe that a rapid rise in Treasury yields, say 1.5% on the 10-year, which would just bring us back to 0% real yields is a big risk to equity valuations. Not only would it mean future profits need to be discounted at higher yields in any model, or that bond yields would again become a little more interesting, but it might also signal fear that the Fed is losing some of its grip on markets. I think a rapid rise in yields is a low-probability event, so am not particularly concerned about it, but would be remiss not to mention it at all. What do do now? I would continue to add exposure to areas that benefit from a persistently low dollar. Emerging markets could be attractive. Commodities and commodity stocks could surprise to the upside. I like European stocks, particularly European financials here. Avoid the globally owned high-fliers (if you still have any left -- I don't, as I underestimated how persistent this move in FANG or whatever the latest acronym is, that has pushed stocks to these levels). (AAPL is a holding in Jim Cramer's Action Alerts PLUS member club. Want to be alerted before Jim Cramer buys or sells this stock? Learn more now.)

Is a Sagging USD Bad for Stocks? Don't Bet Your Bottom Dollar on It

Let's look at what currency moves, the possibility of inflation and real yields could mean for stocks.

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