It should be more than apparent to investors in today’s world that both anticipating and staying in harmony with the direction of currencies is crucial in the process of global asset allocation. As we look back at 2013, it seems clear that global central banker actions in large part helped shape investor behavior. Removing nominal return from safe investments forced those seeking even a modicum of return into what have historically been considered riskier asset classes. In like manner, anticipation of the Fed’s ultimate shift to tapering meaningfully impacted specific global asset class price movement in the second half of the year. The rise of the US equity market resulting from a “there is no other alternative” perception was accomplished on the back of valuation expansion given subdued macro-economic and corporate earnings growth. Lastly, it is also clear that asset class specific price movement in the prior year was driven importantly by global flows of capital wishing to avoid potential confiscation and/or debasement.
But what did not appear to be much of a factor point to point was the value of the US dollar relative to major foreign currencies. Will that change in the year ahead? I suggest we need to consider the forward direction of the US dollar and what that may mean to investor perceptions. Although it’s just my personal view, investment outcomes in 2013 were more about the weight and movement of capital in search of safety and return as opposed being driven by strict fundamental numbers results. Will that still be true in the New Year?
To the point, looking into 2014, changes at the margin in global central banker actions argue for a stronger dollar from an academic perspective. The very fact that the Fed has begun the tapering process puts them at odds with the BOJ directionally. It’s a good bet the US economy continues to forge ahead in terms of incremental GDP growth, while alternatively the Euro economy looks flattish accompanied by low inflation/wisps of deflation. The rise of US interest rates set against the compression in sovereign peripheral European bond yields has been striking. The emerging markets, and their respective currency movements, are very much a function of an intentionally slowing China. Does all of this set the stage for a stronger dollar in 2014?
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Let’s look at a few charts that suggest the near term direction may be higher. The daily chart of the dollar below shows us one of the larger moves of the year came in the direct aftermath of the Jun 19 Bernanke tapering discussion. But with the back pedaling and tapering guessing game created by the Fed in subsequent months, the dollar turned tail and never saw that level again right up to the present. In like manner, the dollar bottomed about six weeks prior to the actual beginning of tapering and is for now tracing out a bit of a rounding bottom formation. A break of the 81½ level to the upside would imply higher short term prices.
What immediately caught my eye in the weekly chart is the 14 period RSI and the history of declining tops trend breaks going back over the entirety of the current cycle. It appears we have arrived at yet another break to the upside juncture, implying some relative dollar strength to come if rhythm of the current cycle is to be any guide.
Finally the monthly is a chart to watch in the coming year. The divergence between price and MACD is now a decade in the making and appears to be resolving to the upside. Very long term trend lines in price as well as RSI lay not so far above current levels. And finally the 50 month MA has been downside support for over two years now, quite the contrast to the prior decade long period of the 50 month being solid upside resistance.
For now, all of this is a snapshot point in time. Collectively, the combination of chart messages suggests the possibility of a higher dollar. We’ll just have to see what happens.
As I mentioned, I’m convinced financial market outcomes last year were more about the movement of capital than they were about discounting near term fundamentals. I think this is important as we consider the direction of the dollar ahead. Remember, we live in a world where corporate profit margins rest at/near all-time highs. Profits as a percentage of US GDP are at all-time highs.
By definition, a rising dollar is not a wonderful thing for the translation of multinational foreign derived corporate profits. Could a higher dollar be a corporate profit margin spoiler in the current year? Indeed it could, but I suggest to you that perhaps the larger question becomes if it were to occur, how will it matter in investor decision making when looking at the global landscape? Profit margins are a fundamental construct, a construct that took a bit of a backseat as a decision making driver in 2013. In contrast, a higher dollar from a global capital perspective would be an attractor of capital in search of rate of return – rate of return driven not only by nominal dollar asset price movements, but also driven by relative currency movements. In essence, we’re back to the same important question as was the case last year — what is taking precedence in financial market outcomes, strict fundamentals or the weight and movement of global capital?
Although I’m just “guessing out loud”, maybe a higher dollar nearer term would help set up the possibility of a more highly volatile price outcome in the current year than was the case with the near linear 2013 outcome. Historically, the second year of a presidential cycle has witnessed heightened price volatility. A 10-20% price correction would not be an anomalistic occurrence. Could a rising dollar be the catalyst for such a possible outcome? It sure could. Yet we need to remember that the variables responsible for setting global capital in motion (rising debasement/confiscation/taxation concerns) have not subsided. In fact, although it’s just my view, these factors will only accelerate global capital seeking safety and rate of return ahead.
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I remain convinced the current financial and economic cycle is like no other in recent history. As such, we need to broaden our perspective as investors well beyond company specific fundamental outcomes to include the weight and movement of global capital. We need to attempt to identify, anticipate and monitor those variables that influence this movement. A potentially rising dollar is a double edged sword. Not positive for US multinational corporate earnings fundamentals, but very positive when viewed from the standpoint of global capital attraction in an increasingly uncertain global central bank and sovereign (taxation) decision making world. Remain flexible.
