The U.S. dollar has been on a downtrend and should that continue, there will be “better things to own than Nvidia” for investors, Gavekal Research said in a Monday report.
The research firm highlighted that a weaker dollar could fundamentally impact the investment landscape, potentially challenging the dominance of high-flying U.S. tech stocks like Nvidia (NASDAQ:NVDA).
Specifically, the report points out that historically, the U.S. dollar's strength has been a key factor in driving capital into U.S. equities. However, as the Federal Reserve signals a more dovish stance, with interest rate cuts on the horizon, the dollar may lose its luster.
“The shift in U.S. monetary policy is bearish for the U.S. dollar," Gavekal explains, which could, in turn, lead to a reallocation of global capital.
The firm presented three potential scenarios for the greenback and its impact on equity markets.
1) The first scenario involves U.S. policymakers attempting to weaken the dollar, but ultimately failing. In this case, the U.S. remains the "cleanest dirty shirt" in the global economy, and capital continues to flow into U.S. stocks, with Nvidia and its peers maintaining their strong performance.
2) The second scenario considers a weaker dollar leading to increased profitability for U.S. corporates, breaking the historical correlation between a strong dollar and strong U.S. equities.
“US equities continue to do fine, even as the US dollar weakens,” the report states.
3) The third and most critical scenario, according to Gavekal, is where the U.S. dollar continues to decline, prompting capital to flow into international markets.
In this case, investors might find better opportunities outside of high-valuation stocks like Nvidia, particularly if the dollar depreciates by around 5% annually.
“Investors decide that if the US dollar is losing -5% a year, there are better things to own than Nvidia at 75 times earnings or Microsoft (NASDAQ:MSFT) at 35 times,” Gavekal emphasizes.
“So far, the market’s reaction to Powell’s speech lies somewhere between scenarios two and three,” the firm adds.
As the Federal Reserve Chairman Jerome Powell spoke on Friday, the U.S. dollar saw a notable decline, while commodities surged. Meanwhile, equity markets also rallied, indicating some alignment with the second scenario.
However, within the equity space, the Russell 2000's outperformance over the NASDAQ Composite and the stronger showing of energy stocks compared to technology signals a shift towards the third scenario.
If the dollar continues to weaken in the coming days, Gavekal strategists believe that the third scenario may prevail.