The co-author of our new book, From Bear to Bull with ETFs, second and revised edition, is Talley Léger. In his most recent MVR Portfolio Strategy missive, Talley asked a critical question:
Why do US share prices display little sensitivity to US dollar fluctuations across time? The fair-value equation for the stock market is expressed by (1) earnings per share (EPS) and (2) the price-to-earnings (P/E) multiple. In strong-dollar regimes, slower earnings growth (read: foreign sales/exports, negative translation effects, and decreased competitiveness) is usually offset by multiple expansions (read: lower inflation, borrowing costs, and discount rates).
While we wouldn't overstate the importance of the US dollar vis-à-vis the S&P 500, it does matter for sector positioning! The relative performance of US defensives is directly related to the US dollar (read: high domestic exposure), whereas the relative performance of US cyclicals is inversely related to the US dollar (read: high foreign exposure).
Here is the link to Talley’s full research piece: http://www.cumber.com/content/special/MVR_PSP_050215.pdf.
On page 9 of Talley’s piece, readers will find the correlation coefficients of US stock market sectors vs. USD periods of strength and weakness. The three strongest sectors when the dollar is strengthening are Financials, Utilities, and Consumer Discretionary. Cumberland’s US ETF portfolios are currently overweight in all three. We particularly like the financials as does Talley’s statistical work. Note that we are underweight energy and materials. About half the US portfolio delves into industry and sector choices; the other half uses more broad based ETFs.
Note that Talley Léger is a subadvisor to Cumberland on our sector rotation model. He authored the middle section of From Bear to Bull with ETFs, on the sectors. We thank Talley for permission to share his research note with our readers.