TEN-YEAR TREASURY YIELD TOUCHES THREE-YEAR HIGH -- STRONG CHINESE ECONOMY PUSHES MAINLAND STOCKS HIGHER -- HONG KONG HITS A NEW RECORD -- A WEAKER DOLLAR FAVORS FOREIGN STOCKS -- FOREIGN STOCK ETFS GET A BOOST FROM RISING LOCAL CURRENCIES
TEN-YEAR BOND YIELD TOUCHES THREE-YEAR HIGH ... The weekly bars in Chart 1 show the 10-Year Treasury Yield touching the highest level in three years today. A decisive close above its late 2016 peak (2.62%) would signal even higher rates. That's a lot better for stocks than it is for bonds. Higher bond yields are also better for economically-sensitive stock groups and those tied to rising inflation. It's not good for bond proxies like utilities and REITs. One of the factors pushing bond yields higher is stronger global economic growth. Stronger growth in foreign markets is also pushing their currencies higher against the dollar. I'll also show again why a weak dollar favors foreign markets over the U.S. That's true for both developed and emerging markets. But first, one of the reasons being given for this week's jump in Treasury yields is stronger growth in China. Let's start there.
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Chart 1
SHANGHAI INDEX REACHES TWO-YEAR HIGH... It was reported yesterday that the Chinese economy during 2017 grew at the fastest pace in two years (6.9%) and showed the first sign of acceleration in seven years. That gave a big boost to Chinese stocks both on the mainland and Hong Kong. The red weekly bars in Chart 2 show the Shanghai Stock Index (plotted through yesterday) rising to the highest level in two years. But that's only a small part of the story. The monthly bars in Chart 3 show the Hong Kong Hang Seng Index closing over 32000 yesterday for the first time to set a new record. [Chinese stocks are rising again today]. Keep in mind that China is the world's second biggest economy. So what happens there effects what happens here and everywhere else. Economic strength is also reflected in rising Chinese interest rates and the yuan. The 10-Year Chinese bond yield has risen above 4% for the first time in four years. Chart 4 shows the WisdomTree Chinese Yuan ETF (CYB) climbing to the highest level in two years. Here's something else to think about. China is the world's biggest importer of commodities. Chinese economic strength could provide an additional tailwind for economically-sensitive commodity prices this year. That could boost bond yields even more.
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Chart 2
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Chart 3
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Chart 4
DEUTSCHE X-TRACKERS CSI 300 CHINA A-SHARES ARE PLAYING CATCH UP... Chart 5 shows the CSI 300 A-Shares ETF (ASHR) rising to the highest level in two and half years. That ETF offers U.S. investors exposure to the 300 largest and most liquid A-Shares traded in mainland China. And Chinese stocks are starting to show global leadership. The red line in Chart 5 plots a relative strength ratio of the ASHR divided by the FTSE All World Index ($FAW). After lagging behind the rest of the world for several years, the ratio bottomed last May and has been rising since then. Since last May, the ASHR has risen twice as fast as the FAW (36% versus 18%). It also outpaced a 30% gain in Hong Kong and a 10% gain in Shanghai. One reason for its stronger performance versus Shanghai is that mainland stocks trade in yuan, while the ASHR is quoted in dollars. A rising local currency gives a bigger boost to foreign stock ETFs which are quoted in a weaker U.S. currency.
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Chart 5
FALLING DOLLAR FAVORS FOREIGN STOCKS ... The direction of currency markets tells us a lot about the relative strength (or weakness) of global markets. As a rule, stronger economies have stronger currencies, while weaker economies have weaker currencies. As a result, the direction of the U.S. dollar tells us whether to favor U.S. stocks or foreign stocks. Generally speaking, a weaker dollar favors investments in foreign stocks. The green line in Chart 6 shows the Dollar Index (UUP) falling since the start of 2017 to the lowest level in three years. During that time, global stocks rallied. But foreign stocks rose faster. That can be seen by the rising blue line which is a relative strength ratio of the Vanguard All-World ex-US ETF (VEU) divided by the S&P 500. That line turned up at the start of 2017 when the dollar peaked. After pulling back during the fourth quarter of last year (as the dollar bounced), the ratio is rising again as the dollar has dropped to a new low. The VEU includes both developed and emerging foreign stocks. Since the start of 2017, the VEU has gained 34% versus 25% gain in the S&P 500.
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Chart 6
EUROPEAN STOCK ETFS BENEFIT FROM STRONGER CURRENCIES... In the current environment, Americans get a dual benefit from investing abroad. One is that they benefit from rising foreign shares which are considered to be less expensive than in the U.S. The other is that they also benefit from rising foreign currencies. The biggest benefits over the last year have been in emerging markets and Europe. A basket of emerging market currencies gained 13% over the last year which contributed to a 46% gain in Emerging Markets iShares (EEM). Like all foreign stock ETFs, the EEM is quoted in dollars and gets an added boost when the dollar is down. In Europe, the euro and British pound gained 16% and 12% respectively, which helped their stock ETFs outperform their local stock benchmarks. The blue line in Chart 7 is a ratio of Germany iShares (EWG) divided by the DAX Index. The red line is a ratio of UK iShares (EWU) divided by the FTSE Index. Since the start of 2017, Germany iShares outpaced the DAX by 20%. That was mainly due to a 16% gain in the euro. UK iShares outpaced the FTSE by 18%. That was largely due to a 12% jump in the pound. And that was mainly due to a falling dollar (green area). Which demonstrates that foreign stock ETFs are one of the best ways to benefit from rising foreign stocks and a falling dollar.
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Chart 7
SMALL CAPS ARE ENDING THE WEEK ON A STRONG NOTE... Despite a little setback on Tuesday afternoon, stock indexes in the U.S. are ending the week on a firm note. That's especially true of smaller stocks. The Russell 2000 Small Cap index is the biggest percentage gainer on Friday. Chart 8 shows the Russell 2000 iShares (IWM) trading 1% higher on Friday. That may be due to the fact that the group is less overbought than large cap stocks. Its 14-day RSI line (purple line) sits at 66 which is below the overbought threshold of 70. By comparison, larger cap indexes are trading closer to 80 which is overbought territory. From a market perspective, it's usually good to see small caps rising. Small stocks are more influenced by U.S. economic trends (which are strengthening), and stand to benefit more from recent tax cuts. And they're usually the first ones to drop at a market top. There's no sign of that today.
