Dollar Defies The 7-Year Cycle

Historically the U.S. Dollar has had a tendency to exhibit strength over a 7-year cycle. In July of this year the Dollar strength cycle crossed into its eighth year though, as seen in the below chart.

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Emerging Markets: An Opportunity?

For a period of time this year, the U.S. equity market avoided the weakness that was occurring in many other equity markets around the world. October has certainly changed this though. As can be seen below, the S&P 500 Index is in correction territory now, i.e., down greater than 10% from its high at the end of September.

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Dollar Strength Leads To Large Cap Stock Outperformance

A recent strengthening of the US Dollar has some investment commentary now favoring small cap stocks over large cap stocks. This is partly due to the earnings headwind that can negatively impact multinational companies as they convert foreign earnings back into the Dollar. One recent report titled, Rising Treasury Yields And Dollar Completely Change Investment Themes, noted:

"The resumption of the bull market has taken shape in the form of small caps. I fully expect that the rest of the market will follow suit eventually, but rising treasury yields and the surging dollar have money rotating feverishly into smaller companies and that relative strength is likely to continue."

In the below chart, a downward trending red line indicates small cap stocks are outperforming large cap ones. In 2018 small cap stocks have outperformed large cap stocks while the US Dollar Index (DXY) has risen from below 90 to almost 94.

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US Dollar Influencing Oil Prices

Nearly two years ago four factors were influencing the energy market and specifically the price of oil. 

• Oil inventory in the U.S. hit a record high
• The price of crude (West Texas Intermediate or WTI) reached a post financial crisis low
• Rotary oil rig count hit a record low of 404
• The trade weighted value US Dollar hit a post financial crisis high

The fact oil inventory spiked is partially attributable to technological advancement in drilling and specifically, increased supply from fracking activity. The subsequent low level of drilling activity that began a few years ago contributed to the supply decline. Today, the rig count has once again moved higher and the oil market may be seeing a potential bottoming of the supply decline, yet oil prices continue to move higher as seen in second chart below.

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Citgroup Economic Surprise Indices Have Little Bearing On Equity Market Performance

One set of indices that seems to cycle from positive to negative over a relatively short period of time are the Citigroup Economic Surprise Indices (CESI). This aspect of these indices means they gain prominence from a commentary standpoint when they reach high and low points. What is important for investors to know is the CESI is a mean reverting index, that by design, cycles between highs and lows over relatively short periods of time. In June of this year, the Citigroup U.S. Economic Surprise Index (CESI-US) was a minus 78 after falling from plus 57 in March. At the June low some commentary began noting the U.S. economy might be headed for a recession. However, the correlation of the S&P 500 Index to the CESI-US is a small negative .04, so actually a slight negative correlation between the two variables.

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Emerging Markets, The Dollar and Interest Rates

This morning I published a few tweets and charts on our Twitter site reviewing emerging market equity performance and the impact US Dollar strength has on emerging market equity performance. Additionally, interest rates influence US Dollar movement and rising interest rates tend to result in a stronger Dollar, all else being equal. Below are those tweets.

Ones view on the direction of the US Dollar critical to emerging market performance. pic.twitter.com/HlPPlJq4D4

— HORANCapitalAdvisors (@HORANCapitalAdv) December 10, 2016

@HORANCapitalAdv At least another year to run on US Dollar strength? pic.twitter.com/tiq4mlIaiH

— HORANCapitalAdvisors (@HORANCapitalAdv) December 10, 2016

@HORANCapitalAdv And higher interest rates lead to stronger US Dollar. pic.twitter.com/PDKZPAuF0m

— HORANCapitalAdvisors (@HORANCapitalAdv) December 10, 2016

@HORANCapitalAdv End of bond bull market? Interest rate curve steepening. Where to invest then? Equity market seems to be saying US stocks. pic.twitter.com/d3IA9cm503

— HORANCapitalAdvisors (@HORANCapitalAdv) December 10, 2016

@HORANCapitalAdv but we are long $HEDJ. Contrarian play? Chart courtesy of @InvstSideKick pic.twitter.com/2hgb8xD5NX

— HORANCapitalAdvisors (@HORANCapitalAdv) December 10, 2016

I frequently provide market relevant tweets throughout the week so feel free to follow our firm on Twitter @HORANCapitalAdv. At the same time, readers may want to follow our broader firm, HORAN on twitter as well @HORAN1948. For over 65 years HORAN has created plans to control health care costs, protect your wealth and insure your life. But the end game for all that we do at HORAN is more than a set of plans. We believe good health and true wealth create a better quality of life for our clients and their families.