This is a follow-on to — A New World Order — posted yesterday. The first 13 minutes are worth listening to.
Michael Every, Global Strategist at Rabobank, says commodities and the US Dollar are key investments in the coming decade.
Westpac: US Dollar capped by dovish Fed (video)
Good short video from Elliot Clarke & Richard Franulovich at Westpac IQ about Aussie/US Dollar prospects and the outlook for the US economy.
Rising yields are lifting the Dollar but the Fed’s dovish stance is expected to cap the Dollar going forward, with the Aussie likely to strengthen above 80 US cents.
The Biden stimulus is likely to help the US economic recovery this year but will wear off by year-end. There are many obstacles to passing a major infrastructure bill but that would be the best way to lift growth prospects over 2022/3 and beyond and help the US keep pace with growth in Asia, where there are more development opportunities.
Markets that are likely to outperform in 2021
There is no reliable benchmark for assessing performance of different markets (stocks, bonds, precious metals, commodities, etc.) since central banks have flooded financial markets with more than $8 trillion in freshly printed currency since the start of 2020. The chart below from Ed Yardeni shows total assets of the five major central banks (Fed, ECB, BOC, BOE and BOJ) expanded to $27.9T at the end of November 2020, from below $20T at the start of the year.
With no convenient benchmark, the best way to measure performance is using relative strength between two prices/indices.
Measured in Gold (rather than Dollars) the S&P 500 iShares ETF (IVV) has underperformed since mid-2019. Respect of the red descending trendline would confirm further weakness ahead (or outperformance for Gold).
But if we take a broad basket of commodities, stocks are still outperforming. Reversal of the current up-trend would signal that he global economy is recovering, with rising demand for commodities as manufacturing output increases. Breach of the latest, sharply rising trendline would warn of a correction to the long-term rising trendline and, most likely, even further.
Commodities
There are pockets of rising prices in commodities but the broader indices remain weak.
Copper shows signs of a recovery. Breakout above -0.5 would signal outperformance relative to Gold.
Brent crude shows a similar rally. Breakout above the declining red trendline would suggest outperformance ahead.
But the broad basket of commodities measured by the DJ-UBS Commodity Index is still in a down-trend.
Precious Metals
Silver broke out of its downward trend channel relative to Gold. Completion of the recent pullback (at zero) confirms the breakout and signals future outperformance.
Stock Markets
Comparing major stock indices, the S&P 500 has outperformed the DJ Stoxx Euro 600 since 2010. Lately the up-trend has accelerated and breach of the latest rising trendline would warn of reversion to at least the long-term trendline. More likely even further.
The S&P 500 shows a similar accelerating up-trend relative to the ASX 200. Breach of the latest trendline would similarly signal reversion to the LT trendline and most likely further.
Reversion is already under way with India’s Nifty 50 (NSX), now outperforming the S&P 500.
S&P 500 performance relative to the Shanghai Composite plateaued at around +0.4. Breakout would signal further gains but respect of resistance is as likely.
Growth/Value
Looking within the Russell 1000 large caps index, Growth stocks (IWF) have clearly outperformed Value (IWD) since 2006. Breach of the latest, incredibly steep trendline, however, warns of reversion to the mean. We are likely to see Value outperform Growth in 2021.
Bonds
The S&P 500 has made strong gains against Treasury bonds since March (iShares 20+ Year Treasury Bond ETF [TLT]) but is expected to run into resistance between 1.3 and 1.4. Rising inflation fears, however, may lower bond prices, spurring further outperformance by stocks.
Currencies
The US Dollar is weakening against a basket of major currencies. Euro breakout above resistance at $1.25 would signal a long-term up-trend.
China’s Yuan has already broken resistance at 14.6 US cents, signaling a long-term up-trend.
India’s Rupee remains sluggish.
But the Australian Dollar is surging. The recent correction that respected support at 70 US cents suggests an advance to at least 80 cents.
Gold, surprisingly, retraced over the last few months despite the weakening US Dollar. But respect of support at $1800/ounce would signal another primary advance.
Conclusion
Silver is expected to outperform Gold.
Gold is expected to outperform stocks.
Value stocks are expected to outperform Growth.
India’s Nifty 50 is expected to outperform other major indices. This is likely to be followed by the Stoxx Euro 600 and ASX 200 but only if they break their latest, sharply rising trendlines. That leaves the S&P 500 and Shanghai Composite filling the minor placings.
Copper and Crude show signs of a recovery but the broad basket of currencies is expected to underperform stocks and precious metals.
The Greenback is expected to weaken against most major currencies, while rising inflation is likely to leave bond investors holding the wooden spoon.
Why is the Dollar falling?
The broad, trade-weighted US Dollar index has been declining since early 2017.
This is the best explanation I have found for current US Dollar weakness. From Bank of Montreal, BMO Nesbitt Burns:
The relationship isn’t perfect, but as a general rule of thumb, the USD declines in years when global growth is above potential. In such years, strong global growth causes commodity prices to rise, which lifts commodity currencies. In addition, strong global growth normally triggers a flood of investment out of developed economies and into emerging economies. As emerging central banks intervene to slow the appreciation of their currencies from these two factors, they sell the USD against EUR and other alternative reserve currencies, thereby causing the USD to decline against both developed and emerging currencies. That dynamic helps explains the USD depreciation in 2017 as well as the 2004-2007 period. The 10Y average of the IMF’s World GDP growth rate is 3.4% and we think that is roughly potential growth. The IMF estimates that global growth will come in at about 3.6% for 2017 and accelerate to 3.7% in 2018.
In addition, the US’s twin deficit fundamental (sum of the current account deficit and fiscal or federal budget deficit as shares of GDP) is another factor that is negative for the USD. Turns in the twin deficit normally precede turns in the USD by 1-2 years and then trends match thereafter. The US’s twin deficit fundamental has been deteriorating for the past two years and is likely to deteriorate further in 2018 and beyond due in part to the tax cuts. When looking at all these factors together with the fact that USD phases tend to last 5-7 years, we feel that we have to forecast a continuation of broad USD weakness—albeit at a slower pace. We project that the broad USD index will fall 1.5% in Q1 and then 1.0% per quarter in each of the remaining three quarters of 2018.
Hat tip to David Llewellyn-Smith at Macrobusiness.
The fall in the Dollar may also be self-reinforcing, as Enda Curran at Bloomberg highlights:
…..On top of the boost already coming from robust global GDP growth, the dollar’s fall over the past year may add over 3 percent to the level of world trade, according to Gabriel Sterne, global head of macro research at Oxford Economics Ltd. Tipping further dollar weakness, the risks are skewed to the upside for Oxford’s baseline forecast for 5 percent growth in world trade in 2018.
“Falls in the value of the dollar oil the wheels of the global financial system, boosting global liquidity by strengthening balance sheets and alleviating currency mismatches,” Sterne wrote in a note. “One important channel is variation in the differential between the cost of raising dollars onshore and offshore. Dollar weakness reduces the cross-currency basis, increases cross-border lending and boosts bank equities.”
The biggest winners will likely be emerging economies given the weaker dollar will lower the value of their dollar-denominated debt, taking pressure off their balance sheets and from credit conditions more generally…..
Finally, from Deutsche Bank (again hat tip to David):
How can it be that US yields are rising sharply, yet the dollar is so weak at the same time? The answer is simple: the dollar is not going down despite higher yields but because of them. Higher yields mean lower bond prices and US bonds are lower because investors don’t want to buy them. This is an entirely different regime to previous years.
Dollar weakness ultimately goes back to two major problems for the greenback this year. First, US asset valuations are extremely stretched. As we argued in our 2018 FX outlook a combined measure of P/E ratios for equities and term premia for bonds is at its highest levels since the 1960s. Simply put, US bond and equity prices cannot continue going up at the same time. This correlation breakdown is structurally bearish for the dollar because it inhibits sustained inflows into US bond and equity markets.
The second dollar problem is that irrespective of asset valuations the US twin deficit (the sum of the current account and fiscal balance) is set to deteriorate dramatically in coming years. Not only does the additional fiscal stimulus recently agreed by Congress push the fair value of bonds even lower via higher issuance and inflation risk premia effects, but the current account that also needs to be financed will widen via import multiplier effects. When an economy is stimulated at full employment the only way to absorb domestic demand is higher imports. Under conservative assumptions the US twin deficit is set to deteriorate by well over 3% of GDP over the next two years.
In summary:
- Rising global growth boosts commodity prices and emerging markets
- Central banks in emerging markets then sell Dollars to slow appreciation of their local currency
- Fiscal stimulus, such as US tax cuts and infrastructure spending, lifts inflation
- Higher inflation causes a bond bear market
- Fiscal stimulus also widens the current account deficit
- Central bank selling, higher inflation, a bond bear market and wider current account deficits all cause a weaker Dollar
Gold: Tall shadows suggest weakness
Tall shadows for the last three days on the spot gold chart suggest selling pressure. Penetration of the rising trendline indicates that the up-trend is slowing. Breach of short-term support at $1330/ounce would signal a test of medium-term support at $1300. Respect of support would confirm a healthy primary up-trend, while breach would indicate weakness.
* Target calculation: 1300 + ( 1300 – 1050 ) = 1550
At present I don’t see much threat to support between $1300 and $1310. Safe-haven demand for gold is boosted by uncertainty in Europe, the US election dilemma (a choice between two equally undesirable alternatives), and the declining Yuan.
USDCNY retraced to test support at 6.60. Sell-off of USD currency reserves by the PBOC — to support the Yuan or at least slow its decline — helps to suppress US Dollar appreciation. This is a win-win for gold bulls. A weak dollar enhances the price of gold while a falling Yuan encourages capital flight and — you guessed it — demand for gold.
Reserve currency status: Privilege or burden?
Is the reserve currency status of the US Dollar a privilege or a burden? Michael Pettis suggests the latter and argues in favor of constraining unlimited purchases of US or other government bonds by international trading partners like China and Japan:
…it is actually quite easy to list the conditions under which reserve currency status encourages growth and the conditions under which it forces a rise either in debt or in unemployment. In advanced countries with deep and flexible financial markets, except in the case in which capital has become severely constrained by the need for money to be backed by gold, or real interest rates have been forced up to extremely high levels in order to break inflation as was the case in the late 1970s and early 1980s, the net inflows associated automatically with reserve currency status will not result in an increase in productive investment. They only result in an increase either in debt or in unemployment.
This is not an argument in favor of returning to gold, by the way. It is completely neutral on the issue. This argument simply restates the Keynesian insight that eliminating the discipline imposed by the gold standard is likely to become destabilizing unless there is another way to impose discipline…..
….the potentially destabilizing effect is no longer so distant. In a recent essay I tried to show that if we have not already reached the point at which the dominant reserve currency status of the US dollar is harmful to the US and potentially destabilizing to the world, logically we will inevitably reach that point, and probably soon….
I have frequently argued that capital account inflows into US Treasuries artificially inflate the dollar, give trading partners a competitive advantage, and cause the loss of millions of manufacturing jobs. Failure to address this issue is one of the major causes of low wage growth and rising inequality in the US.
Read more at Are we starting to see why its really the exorbitant “burden” | Michael Pettis' CHINA FINANCIAL MARKETS.
Aussie Dollar threatens breakout, Euro tests support
The Aussie Dollar continues to test resistance at $0.94. Recovery of 13-week Twiggs Momentum above zero suggests continuation of the up-trend, testing resistance at $0.97. Reversal below $0.92 is unlikely at present, but would warn of a decline to the band of support between $0.87 and $0.89.
The Euro respected primary support at $1.35 and the rising long-term trendline. Recovery above $1.37 would suggest a rally to $1.39/$1.40, but descending 13-week Twiggs Momentum crossed below zero, warning of weakness. Breach of $1.35 would signal a decline to $1.31*.
* Target calculation: 1.35 – ( 1.39 – 1.35 ) = 1.31
Japan: Dollar supports Nikkei
The US Dollar found support at ¥101 against the Yen. Recovery above the May high at ¥104 would suggest a healthy up-trend, while breakout above ¥106 would offer a target of ¥110*. Divergence on 13-week Twiggs Momentum remains bearish, but another trough above zero would reverse this. Breach of support at ¥101 now seems unlikely, but would warn of trend weakness.
* Target calculation: 106 + ( 106 – 102 ) = 110
A rising Dollar/Yen exchange rate would assist Japanese stocks. The Nikkei 225 found support at 14000 on the monthly chart. Recovery above 15000 would suggest another advance, while breakout above 16000 would confirm. Reversal of 13-week Twiggs Money Flow below zero, however, would warn of a primary down-trend.
Japan: Nikkei falls as Dollar weakens
The US Dollar is testing support at ¥102 to ¥103 against the Yen. Breach of the rising trendline would strengthen the warning from a bearish divergence on 13-week Twiggs Momentum. Reversal of Momentum below zero would suggest a primary down-trend. Recovery above ¥104 is less likely, but would offer a target of ¥110*.
* Target calculation: 106 + ( 106 – 102 ) = 110
A rising Dollar/Yen exchange rate would assist Japanese stocks. The Nikkei 225 is testing support at 15000 after penetrating its rising trendline. Bearish divergence on 13-week Twiggs Money Flow warns of selling pressure. Reversal below 15000 would indicate a strong correction, while a Twiggs Money Flow cross below zero would warn of a primary down-trend.
Forex: Dollar and Sterling strengthen
The Euro is rallying for another test of resistance at $1.37 after finding support at $1.3350 against the greenback. Troughs above zero on 13-week Twiggs Momentum suggest a healthy up-trend. Breakout above $1.37 would signal an advance to $1.40*. Respect of resistance, indicated by reversal below the secondary rising trendline, would, however, warn of a correction to the primary trendline at $1.31.
* Target calculation: 1.37 + ( 1.37 – 1.34 ) = 1.40
Sterling breakout above resistance at €1.20 signals a primary up-trend. Recovery of 13-week Twiggs Momentum above zero strengthens the signal. Target for the advance is €1.23*. Reversal below €1.19 is unlikely, but would warn of another test of €1.1650.
* Target calculation: 1.20 + ( 1.20 – 1.17 ) = 1.23
The Greenback is likely to retrace to test the new support level at ¥101 Japanese Yen. Respect would confirm an advance with a target of ¥108*. The trough above zero on 13-week Twiggs Momentum strengthens the signal. Reversal below ¥101 is unlikely, penetration of the rising trendline warning of trend weakness.
* Target calculation: 1.01 + ( 1.01 – 0.94 ) = 1.08
Canada’s Loonie broke primary support at $0.94, signaling another decline with a target of $0.915*. A peak below zero on 13-week Twiggs Momentum strengthens the signal. Recovery above $0.945 is unlikely, but would warn of a bear trap.
* Target calculation: 0.945 – ( 0.975 – 0.945 ) = 0.915
The Aussie Dollar is heading for a test of primary support at $0.89. The peak below zero on 13-week Twiggs Momentum signals continuation of the down-trend. Breakout below $0.89 would offer a long-term target of $0.81*, while respect of support would suggest a rally to $0.93. The RBA needs a weaker Aussie Dollar, without lowering interest rates, and will do all it can to assist the decline.
* Target calculation: 0.89 – ( 0.97 – 0.89 ) = 0.81