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The U.S. Dollar bottoming is sending shock waves through financial markets. The U.S. Dollar index is up 5.8% from its 2018 lows. Meanwhile... Emerging Markets (EEM) are down -11.2% (peak-to-present). Equity markets in Argentina and Turkey are getting knee-capped by a one-two punch of rising debt loads and political risk.
Italy too is reminding investors that the problems plaguing Europe for the better part of a decade (debt, deficits and poor demographic trends) are present and pervasive, despite the ECB's best efforts to prop up the Continent.
It's no surprise all of this is happening as the U.S. Dollar bottoms. In fact, market history suggests this is precisely what should happen. Why?
In the spirit of "Throwback Thursday" we're revisiting our Dollar #Bottoming call from our institutional Macro teams 2Q 2018 Macro Themes presentation. The chart at the bottom of this note summarizes precisely why we made this call...
But before we get to that, here's the necessary backstory...
We find two factors to be most consequential for forecasting future financial market returns: economic growth and inflation. We track both on a year-over-year rate of change basis to better understand the big picture then ask the fundamental question: Are growth and inflation heating up or cooling down?
From there, we get four possible outcomes, each of which is assigned a “quadrant” in our Growth, Inflation, Policy (GIP) model and the typical government response as a result (neutral, hawkish, in-a-box or dovish):
- Growth accelerating, Inflation slowing (QUAD 1);
- Growth accelerating, Inflation accelerating (QUAD 2);
- Growth slowing, Inflation accelerating (QUAD 3);
- Growth slowing, Inflation slowing (QUAD 4)
Where are we now?
Simply put, our GIP model is predicting global growth transitions from an environment of #GrowthAccelerating (Quads #1 and #2) to one of #GrowthSlowing (Quads #3 and #4). As you can see in the chart below Quads #3 and #4 have been positive for the Dollar. In short, as global growth slows the U.S. dollar starts to appreciate.
From there you'd expect precisely what's happening now in financial markets: Emerging Markets get clobbered (particularly those holding the $3.5 trillion in dollar denominated debt) and other slowing economies (like Europe and China) see equity market underperformance relative to the U.S. (The Nasdaq and Russell 2000 hit all-time highs yesterday.)
We made the Dollar #Bottoming call (and the resulting investing implications) in April and we're sticking with it.
If you missed the first part of this move, don't fret. To get up to speed on our Dollar #Bottoming call, we highly suggest you check out each of the following complimentary research notes and video webcasts:
Our Dollar #Bottoming call is far from over. Stay ahead of the pack with these sharp investing insights.
Happy Thursday!
