Market Strategy Radar Screen Weekly July 24, 2017

 Give Me Money That’s What I Want

We quote the Beatles on the effects of currency trends on the performance of international assets.

We maintain our bullish stance on the equity markets as economic fundamentals at home and abroad keep improving, albeit at a mixed and modest pace.

Revenues and earnings for the S&P 500 have broadly improved the last three quarters reported, and in the current reporting season (for Q2) earnings thus far continue to surprise to the upside with about a fifth of companies in the S&P 500 having thus far reported.

Low inflation linked to technology—robotics on the factory floor and algorithms in the office—along with the effects of globalization and technology on companies worldwide (via lower barriers to entry for competition) is likely helping the Fed as well as other central banks around the world deliver a process of interest rate normalization that should take longer to effect but with less disruptive results for the markets than many expect.

For now we see greater risk in bonds than in stocks as central banks remain committed to the process of normalization at a modest pace. A slower pace of rate hikes in small increments while overall likely less disruptive to the system than normalization at a quicker pace and in greater percentage amounts should still likely be easier digested by stocks than bonds. Broadly speaking, current fixed income yields appear to us to be at low levels not likely to provide much offset to declines in bond prices when and if the process of normalization gains greater traction. Stocks on the other hand are likely to benefit from improvements as the pace of economic growth reflects positively on revenues and earnings.

From our perspective the recent rally across several asset classes evidences not so much investors acting in concert across the asset classes involved but rather separate and distinct constituencies which exist among investors (equity folks, bond folks, gold bugs, various categories of commodity players, real asset folks) that are simply “sticking to their guns” and supporting their respective favorite assets to match their opinions, needs and objectives.

Monetary policy which mixes dovish and hawkish trends contributes to economic and market conditions which while in transition—ultimately towards some kind of normalization of interest rates—takes form in a “two steps forward to one step back” process of price discovery among currencies and asset classes.

In such an environment we continue to believe that the equity markets stateside and abroad offer opportunities that stand out as a process of economic recovery abroad gathers steam and has opportunity to develop into sustainable economic expansions parallel if not equal to that occurring in the US at present time.

Money Matters amplified by FX (currency) markets

On a year to date basis international markets have broadly outperformed most of the stateside major equity indices. However, a quick glance under the hood reveals that much of the outperformance of the US markets by international markets has been as a result of the dollar weakening against a broad array of developed, emerging and even frontier currencies since the start of the year.

When taken from the perspective of their respective and relative performances in local currencies the gains and outperformance by the international holdings are not so pronounced or outsized as they might first appear when translated into dollars.

We suggest a quick, at-a-glance sampler of the effect of currency trends on returns for a US currencybased investor so far this year:

Let’s consider the DAX, the leading equity index of Germany. In local (euro) terms the DAX through last Friday’s close in Europe was up 6.61%. Translated into US dollars? The DAX stood 18.24% higher through the close last Friday boosted by the strength of the euro against the dollar so far this year.

The UK’s principal equity index, the FTSE 100, up just 4.43% year to date in British pounds looks considerably better when translated into dollars—up 9.93% in the same period.

In developed Asia, the Nikkei 225 (Japan’s leading index), was up 4.27% year to date as of last Friday. In dollar terms? The Nikkei was up 10% in the same period.

In Emerging markets an at-a-glance sampler shows Korea’s Kospi up 20.92% versus 29.88% in US dollars year to date. Taiwan’s TAIEX index was up a respectable 12.7% year to date through last Friday. Translated into dollars the benchmark’s return soared 19.6% in the same period.

Thus far this year the dollar’s decline against a broad array of currencies including all of the G10 currencies and declines against 19 of 24 major emerging market currencies has provided a boost for investors based in the US.

At the same time the weakness of the dollar has cheapened the cost of dollar-based commodities for foreign buyers as well as provided a boost to US multi-national competitiveness.

Our expectations are for the dollar to continue moderating in strength as the year progresses. In our view the dollar has a tendency in recent history to strengthen in anticipation of a Federal-Reserve-led rate hike cycle and then trend towards weakening as the process of normalization gets under way.

So far so good but regardless of this friendly trend we suggest that investors “don’t forget which side the bread is buttered on” when it comes to what’s been driving the outperformance achieved by many international markets so far this year—currency.

For the complete report, please contact your Oppenheimer Financial Advisor.

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