US DOLLAR STARTS THE YEAR ON A STRONG NOTE -- A FIRMER GREENBACK DURING 2014 WOULD FAVOR U.S. STOCKS OVER FOREIGN STOCKS -- A STRONGER DOLLAR WOULD ALSO WEIGH ON COMMODITY PRICES -- EAFA ISHARES ARE NEARING A TEST OF 2007 HIGHS
US DOLLAR STARTS THE NEW YEAR ON A STRONG NOTE ... The U.S. dollar has entered 2014 on a strong note. Chart 1 shows the U.S. Dollar Index ($USD) trending higher during January which continued its stronger pace since late October. The USD is now moving up to challenge its November peak and 200-day moving average (red line). Closes above those two barriers would be a bullish development for the greenback. The dollar has outpaced all major foreign currencies over the last three months, with the exception of the British Pound. The BP gained 2.4% versus 1.3% for the dollar. All other foreign currencies were weaker. The dollar's biggest gains have come against the Japanese Yen (-5.7%) and the Canadian Dollar (-5.8%). The Aussie Dollar (which isn't included in the USD) lost -7.1% over the last three months, while emerging market currencies lost -3%. One of the reasons for the greenback's strength is the Fed's decision to begin its bond tapering program. That's occurring while foreigners are boosting their QE programs. Japan continues to buy bonds in order to weaken the yen and end a 15-year deflation. Europeans have issued new warnings about deflation and may start their own QE bond-buying program. Rising bond yields weaken the appeal of emerging market assets, including currencies. All of those trends should strengthen the dollar during 2014.
(click to view a live version of this chart)
Chart 1
RISING DOLLAR FAVORS US STOCKS ... One of the side-effects of a stronger dollar is that it favors U.S. stocks. The green line in Chart 2 shows the US Dollar Index bottoming in 2008 and again in 2011 after a multi-year drop that started in 2002. The blue line is a "ratio" of EAFE iShares (EFA) divided by the S&P 500, while the red line divides Emerging Market iShares (EEM) by the SPX. The chart shows that the relative performance of both foreign benchmarks is inversely correlated to the trend of the dollar. Foreign shares outperformed the US (rising ratios) while the dollar dropped between 2002 and 2008. The blue line peaked in 2008 when the dollar bottomed and has weakened since then. The red line started dropping during 2011 when the dollar formed its second bottom. Both foreign lines have underperformed the US (falling ratios) since then. And they're doing so again during the first month of 2014. Foreign stocks and currencies tied to commodities are among the worst foreign performers. They include Australia, Russia, and China. That's not too surprising considering that a stronger dollar also hurts commodity prices.
(click to view a live version of this chart)
Chart 2
RISING DOLLAR HURTS COMMODITIES... A firmer dollar since 2008 also explains why commodities have done so badly since then. That's because commodity prices trend in the opposite direction of the dollar. Chart 3 shows the commodity boom (rising CRB Index) that started in 2002 when the dollar peaked (falling Dollar Index). The commodity bull run ended in 2008 when the dollar bottomed (see arrows). A rising dollar since 2011 (rising trendline) has coincided with falling commodities (falling trendline). A rising dollar during 2014 would make it more difficult for commodities to emerge from their current downtrend.
(click to view a live version of this chart)
Chart 3
EAFE ISHARES AT SIX-YEAR HIGH -- EMERGING ISHARES STILL LAG... EAFE iShares (EFA) measure the trend of foreign developed markets. The weekly bars in Chart 5 show the EFA trading at the highest level in six years which is a positive sign. The chart, however, shows that the EFA is within 350 points (3.5%) of its 2007 high. Some caution may be warranted as it nears a test of that important chart barrier. Market uptrends often stall, or pull back, after reaching important previous peaks. The major trend, however, is still higher. The biggest contributors to EFA gains have been Britain, Germany, and Japan. They offer an attractive alternative to investors who wish to increase their foreign diversification. By contrast, emerging markets continue to lag behind. Chart 5 shows declining peaks in Emerging Market iShares (EEM) since 2011. The four biggest contributors to that decline were Brazil (-40%), Russia (-29%), India (-23%), and China (-14%). Some money managers have been recommending more exposure to emerging markets because of their relatively low valuations. While that may be true, I'd prefer to wait until the group shows more strength. In my view, that would require a decisive close above its late 2013 peak near 43.52.
(click to view a live version of this chart)
Chart 4
