WEAK COMMODITIES HURT PRODUCERS LIKE BRAZIL AND CANADA -- THAT'S A SIDE-EFFECT OF A STRONGER U.S. DOLLAR -- WEAK CANADIAN DOLLAR IS PUTTING DOWNSIDE PRESSURE ON CANADA ISHARES -- VANGUARD EX-USA STOCK INDEX REMAINS STALLED BELOW 2011 HIGH
BRAZIL AND CANADA ARE UNDERPERFORMING THE U.S.... Last Thursday's message focused on the side-effects of a stronger U.S. dollar. One of the most notable intermarket effects was weaker commodity markets. Another is that a firmer dollar favors U.S. stocks over foreign stocks. I showed a chart demonstrating that foreign stocks usually lag behind the U.S. when the dollar is rising, which has been the case during 2013. [One big exception to that rule is Japan, which has matched U.S. gains on a tumbling yen]. I ended one of the paragraphs with the claim that "Countries that produce commodities (like Brazil and Canada) may also be negatively impacted by weaker commodity prices". I'd like to elaborate on that theme today. Chart 1 shows the S&P 500 rising much further than Canada iShares (red line) and Brazil iShares (blue line) over the past two years. During that period, the S&P 500 rose 18% versus losses of -11% for Canada and and -21% for Brazil. What accounts for the weaker performance of those two commodity producers? In my view, it's the stronger U.S. dollar and weaker commodity prices. During those same two years, the U.S. dollar rose 7% while the CRB Index of commodity prices fell -17%. The Brazil and Canadian currencies both lost -5%.
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Chart 1
COMMODITY WEAKNESS HURTS COMMODITY PRODUCERS... Chart 2 is intended to show the impact that commodity prices have on the performance of Brazil and Canadian stocks versus those in the U.S. The red line plots a relative strength "ratio" of Canada iShares (EWC) divided by the S&P 500 over the last decade. The blue line plots a ratio of Brazil iShares (EWZ) divided by the SPX. The brown area represents the CRB Index of nineteen commodity markets. The first half of the chart shows rising commodity prices helping the relative performance of Brazil and Canada (rising ratios). That stronger performance by commodity producers ended during the middle of 2008 when commodity prices tumbled (first brown arrow). Those two producers took a second hit during 2011 when commodity prices turned down again (second brown arrow). Falling commodity prices over the last two years contributed to the weaker Brazil and Canadian performance (falling ratios), and accounts for the weaker numbers reported in the preceding paragraph. U.S. dollar bottoms during 2008 and 2011 contributed to the two CRB downturns. Weakness in Chinese stocks (which is the world's biggest commodity importer) has also contributed to commodity weakness over the past few years. But that's the subject of a future message.
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Chart 2
CURRENCY IMPACT IS FASTER WITH FOREIGN ETFS... One of the reasons I prefer to chart foreign stock ETFs instead of their cash indexes is because the impact of foreign currency movements are seen first in ETFs. To an American investor, the ETF more accurately measures the impact on foreign holdings. The next two charts demonstrate that difference. Chart 3 shows the uptrend in the Toronto Composite Index (TSX) having stalled over the last month. The TSX is down today but remains above its 50-day moving average (blue line). Chart 4, however, shows Canada iShares (EWC) having already fallen below its 50-day line, and looking much weaker than the TSX. The reason for that weaker performance is due to currency trends. The red line below Chart 4 plots "ratio" of the EWC versus the TSX. The green line shows the falling Canadian Dollar (CDW). Both lines have fallen together since January. In other words, a weaker Canadian dollar causes its stock ETF to fall faster than its cash index. That's because the EWC is quoted in a stronger U.S. dollar, while the TSX is quoted in a weaker Canadian dollar. An entity quoted in a stronger currency (EWC) will always fall faster than one quoted in a weaker currency (TSX). That's true of all foreign stock ETFs. To my mind, the relative weakness of foreign stock ETFs (like Canada iShares) provide another warning that foreign stocks are weakening.
(click to view a live version of this chart)
Chart 3
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Chart 4
FOREIGN STOCKS REMAINS BELOW 2011 HIGH ... While it's true that a stronger dollar has helped make the U.S. the strongest market in the world (along with Japan), there's a caveat to that. While the U.S. market is showing better global "relative" strength, it needs some upward confirmation from rising foreign markets. In other words, the U.S. market can't keep rising all by itself. Right now, the rally in foreign markets has stalled. The weekly bars in Chart 5 show the Vanguard FTSE All-World ex-US ETF (VEU) stalled below its 2011 high (overhead shaded area). The VEU includes the world's biggest developed markets (including Canada), and has a 25% weight in emerging markets (which include Brazil and China). So far, no serious downside damage has been done to the chart. The VEU has basically been trading sideways since January. It also remains above a rising trendline and chart support along its 2012 high. Bottom line, however, is that the U.S. market needs stronger foreign performance to push the S&P 500 into record territory, and keep it there. Weaker foreign stocks are causing some profit-taking in the U.S. The fact that the S&P 500 is up against record highs, and in an overbought condition, is also causing some selling.
