One of the biggest influences on global markets that we are keeping a very close eye on is the United States dollar, since the current situation looks a lot like what transpired during the 2000 technology rollover.

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The U.S. dollar, as represented by the U.S. Dollar Index (DXY), rallied nearly 30 per cent during the monster technology rally from 1995 to its peak in March 2000. As the tech sector subsequently imploded, the U.S. dollar, not surprisingly, became the safety trade, rising another 15 per cent through to January 2002 even as the U.S. Federal Reserve rapidly lowered rates.

What followed was quite interesting, as the U.S. dollar fell a whopping 40 per cent by March 2008, giving back nearly all those previous gains. There were also two large moves by the Fed to take rates higher from May 2004 to August 2006, and the U.S. dollar rallied 12.5 per cent and then fell 22 per cent as rates were dropped down again.

During this time, the S&P 500 significantly underperformed international markets that benefited from a falling dollar as commodities and other goods became that much cheaper. For example, if you invested in the S&P 500 from January 2000 to January 2008, your return would have been essentially flat. Worse yet, as a Canadian investor, you would have lost more than 31 per cent in currency exchange.

Compare this to the MSCI EAFE index’s rise of nearly 75 per cent over the entire period, while the S&P/TSX composite index rose almost 54 per cent.

For some current perspective, we calculate the DXY was up 26 per cent from January 2021 to October 2022, and more than 40 per cent from its March 2011 lows, not unlike what transpired prior to the 2000 tech collapse.

Imagine the global impact this has had on the demand for commodities, especially in emerging markets such as China, and then wonder what might happen to this demand as the U.S. dollar falls back down, as it has already given back eight per cent since last September. History doesn’t repeat, but we’ve learned it can certainly rhyme.

Compounding matters is that commodity price weakness has resulted in a large underinvestment in supply, creating an imbalance.

The S&P 500 is now probably the most crowded and concentrated trade globally, not unlike 1999, when technology was 29 per cent of the index and energy was only 5.6 per cent.

In March 2022, technology was at 28 per cent and energy at only 3.6 per cent, but with the correction last year, technology’s weighting is down to 23.5 per cent — still at a high level — while energy is up to five per cent. For an idea of the potential move from here, technology in 2008 was only 15.4 per cent of the index and energy was up 13.1 per cent.

To get a measure of just how out of balance the current situation is, the MSCI USA index has never traded at such a large premium to the MSCI World index going back to 1971. The ratio is now at 1.4x, compared to the 2002 high of 1.09x. We’ve read that this is more than a three-standard-deviation event.

Now, to be fair, this has been a value trap trade for the greater part of the past decade because the U.S. equity markets were given rocket fuel by the Fed via quantitative easing.

We think the key catalyst for change, however, has been the onset of inflation due to all the stimulus from excessive, and perhaps reckless, fiscal spending paired with loose monetary policy that forced the Fed to rapidly raise interest rates at a pace never undertaken before.

We expect inflation to continue to temper, but wage growth could mean it may not fall as much as many expect, certainly not below the recent two-per-cent target. This means we could be in for a holding pattern scenario, which is not good for long-duration tech stocks.

We would even go so far to think this could finally usher in an end to the superior performance of the U.S. dollar and the S&P 500, similar to what happened in the early 2000s.

Now, we are not advocating an all-in reshoring of asset allocations, but given what has transpired historically, there could be some downside risks for Canadian investors who remain significantly overweight U.S. assets in this unfolding environment.

So, we ask, why not take a more balanced approach in the event the markets start rhyming again?

Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.

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