The S&P 500 Index SPX is not the best way to profit from an anticipated Fed pivot. The Federal Reserve has decided to reduce the pace of its rate hikes, but not because of the U.S. equities won't rally. A U.S. dollar-based investor may find that another category of stocks is quite likely to be a better performer for a U.S. dollar-based investor.
I refer to international equities. It is a good bet that the U.S. dollar's strength will weaken against other currencies after a Fed pivot, and if that happens, an investment in non-U. The past couple of months provide a powerful illustration of double-return potential. The U.S. Dollar Index DXY has fallen 8.3% through December 5, since its high on Sep. 28. Over the 2 month period, MSCI's ACWI-ex U.S. Index reflects the return of an index of non-U. S. stocks beat the S&P 500 by 6.4 percentage points -- 14.2% versus 7.8%. These returns compare the MSCI ACWI ex-U of iShares. The dollar's decline accounts for almost all of the MSCI ETF's outperformance, as seen by the S. ETF ACWX and the SPDR S&P 500 ETF SPY.
The fate of the dollar on foreign exchange markets depends on more than on when the Fed decides to pivot. It depends on what the central banks of the United States major trading partners will do at the same time. It is a good bet that the Fed will pivot well before the central banks will do so.
Even though the Fed was late to the game in recognizing inflation's persistence, European central banks were even later. The eurozone inflation is higher than the US inflation, which is 10.0% versus 7.5% over the past 12 months.
Given the lower U.S. inflation rate, you d expect the U.S. 10 year government bond yield TMUBMUSD 10 Y to be lower than the comparable eurozone government bond. The U.S. 10 year yield is currently higher: 3.7% versus 2.8%.
The Fed has the room to easing before Europe, according to these differences. We saw early indications of this when Fed Chairman Jerome Powell announced that the Fed was prepared to slow the pace of its rate hikes, but European Central Bank President Christine Lagarde stated that more rate hikes are in order.
To the extent you are confident that the dollar's foreign exchange value has declined, you would want to move your equity portfolio's asset allocation away from U.S. stocks to non-U. Even if you are not agnostic about the fate of the dollar, you d want to have your equity portfolio split more or less evenly between the U.S. and non-U. Concentrate your portfolio in US-based companies only if you believe that the dollar's foreign exchange value will continue to rise even more than it already has in recent years.
Mark Hulbert is a regular contributor to MarketWatch. He can be reached at mark hulbertratings.com
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