This note was originally published October 23, 2013 at 16:06 in Macro
- It feels like what has been working on an intermediate-term TREND basis is now starting to break down and/or underperform, while the things that haven’t been working on that duration are starting to break out and/or outperform. Is this something you guys are seeing as well? How do we take advantage of this shift?
- What does “Down Dollar, Down Rates” mean to the US economy? Aren’t lower interest rates good for the consumer?
- If the dollar and rates break down, would that make you bullish on emerging markets?
- So what do I do with all of this as it relates to my gross and net exposures?
It’s no secret that US monetary and fiscal policy is generating a fair amount of consternation, confusion and contempt among global financial market participants.
As one of the few non-buyside teams that possess a consistent and repeatable process for interpreting and risk-managing the never-ending stream of market signals and economic data, we have been humbled by a large number of thoughtful questions over the past couple of days. As such, we thought we’d pull together a quick synopsis of said client interactions with the intent of supplementing your respective internal debates.
Q: It feels like what has been working on an intermediate-term TREND basis is now starting to break down and/or underperform, while the things that haven’t been working on that duration are starting to break out and/or outperform. Is this something you guys are seeing as well? How do we take advantage of this shift?
Between the politically compromised FOMC and the highly politicized, dysfunctional mockery of government on Capitol Hill, it’s becoming increasingly clear to us that both market participants and economic agents are interpreting recent policy deltas as supportive of a return to the pre-2013 Global Macro playbook of being addicted to the drug that is QE. At least that’s precisely what the math suggests.
The TREND-duration directional relationship between the USD and US equities/US equity market volatility has completely reversed in recent weeks. Additionally, the positive correlation between the USD and US interest rates is picking up steam amid what appears to be the start of a #WeakDollar + #RatesFalling regime. The things that are typically inversely correlated to the USD are becoming dramatically more so as investors respond to the US dollar’s accelerated breakdown.
The US Dollar’s long-term TAIL line of support is under attack – as is the UST 10Y Yield’s intermediate-term TREND line of support. Is this a head-fake or will these new regimes hold in spite of a positive seasonal tailwind in labor market data from now through MAR? At the bare minimum, preliminary analysis of Janet Yellen’s recent contributions to the FOMC suggests that an #IndefinitelyDovish Fed is NOT a low-probability event. If you have yet to review our SEP 23 note titled, “THINKING LIKE A FED HEAD”, we strongly encourage you to do so; its conclusions are looking increasingly prescient by the minute.
After underperforming all year, higher-yielding equities are starting to outperform. While it’s too early to emphatically proclaim a reversal of the existing trend, the developing quantitative signals highlighted above might lend some expediency to the development of a new one.
Commodities are the lone holdout from an asset class perspective, with both Gold and the CRB Index continuing to make lower-highs amid a bearish TREND and TAIL setup.
We continue to have a zero percent asset allocation to commodities (and fixed income). Make no mistake, however, we’d be buyers of Bernanke’s commodity and bond bubbles if the quantitative signals support that. Like most consistently effective asset allocators, we have no qualms about going both ways and changing our minds on a particular market when the quantitative and fundamental signals support making the switch.
As the chart above highlights, our dynamic asset allocation model is heavily invested in international equities and foreign currencies. We remain the #EuroBulls as the Germans and Brits looks to increasingly take share from the US in the global capital allocation pie chart. Remember, capital chases yield and currency appreciation – with the latter being another way to state that capital tends to flee from domestic currency debasement by seeking out inflation hedge assets, including other currencies.
Q: What does “Down Dollar, Down Rates” mean to the US economy? Aren’t lower interest rates good for the consumer?
Regarding the first part of the question, the confluence of #WeakDollar and #RatesFalling has historically been associated with economic environments that are characterized by slowing growth and accelerating inflation. Conversely, the polar opposite economic setup (growth accelerating as inflation decelerates) has historically been associated with a #StrongDollar + #RatesRising regime.
In our 4Q13 Macro Themes deck, we purposefully led off with two potential economic scenarios for the US here in the fourth quarter. As of now, it appears increasingly likely that a trip to Quad #3 (growth slowing as inflation accelerates) is in the cards. If our historical back-tests provide any insight, that setup should apply downward pressure upon the domestic equity market and upward pressure upon domestic credit spreads.
Regarding the latter part of the question, Keith had this to say in response to the client’s inquiry:
“Lower rates have been capitalized on by anyone w/ half a brain. That’s not to say you don’t get the brainless to refi this next go-round, but the pools of people affected get smaller with each higher-lows in rates, and the real upside to rates rising is in real-incomes rising alongside the savings rate.”
Q: If the dollar and rates break down, would that make you bullish on emerging markets?
Absolutely. We were wise to suspend our street-leading bearish thesis on emerging markets by covering our EEM short on SEP 9; we followed that up with an extremely detailed report on SEP 19 with how to play emerging markets across countries and asset classes from here – the conclusions of which remain relevant today.
To recap our views on emerging markets, the iShares MSCI Emerging Markets ETF declined a cumulative -2.4% from its APR 23 addition to our Best Ideas list – which came in conjunction with our 100+ slide Black Book titled, “EMERGING MARKET CRISES: IDENTIFYING, CONTEXTUALIZING AND NAVIGATING KEY RISKS IN THE NEXT CYCLE” – to our SEP 9 cover. The aforementioned delta is well shy of the +5.9% gain for the S&P 500 over that time frame and was inclusive of a maximum drawdown of -12.8% during the ~2M period from APR 23 to JUN 24. The EEM ETF is up +4.3% since we covered our short on SEP 9 and is now bullish TREND.
What’s outperforming? To a large degree, the bombed-out markets which became dramatically oversold during the prolonged EM rout which took place earlier this year.
While it would be analytically reckless for us to tell you to go out and speculate in the most risky of markets at the current juncture, we do feel confident in saying that in the absence of a clear uptrend in both the USD and US interest rates, investors should resort to trading emerging markets on idiosyncratic country fundamentals – something we highlighted earlier this week in a deep dive on India’s evolving political landscape.
Q: So what do I do with all of this as it relates to my gross and net exposures?
In a word, #GetActive. That means lower your gross exposure, tighten your net exposure and trade the ranges. Don’t make it any more complicated than that amid all of this policy uncertainty – especially if you’ve also had a good year and don’t want to give back any YTD gains.
Many thanks for your time and please keep the questions coming; we are always in the market for thought-provoking discourse.
Have a wonderful evening,
Associate – Macro Team