Last week’s could be best wrapped up by this heat map from Finviz showing the one week performance for the ETF universe. Unless it was inverse or tied to volatility, it was nothing but shades of green last week as the FOMC officially ran out of patience but the doves delivered an unexpected surprise via the dot plot.
The FOMC has reduced their growth expectations without tying it to a natural event which required them to reduce their interest rate forecasts, bringing them closer to those of the primary dealers. While the Yinzer Analyst is tempted to do a victory dance for calling a bump and run formation for the U.S. Dollar (using UUP), he’s tempered because he sure didn’t see the FOMC cutting its outlook. Well neither did anyone else, but that’s not the point.
What is the point is that the shift in the FOMC’s outlook is going to have serious ramifications on the market via two mechanisms; the first is explicit through the interest rate outlook. We talked a while back about how the Fed’s interest rate outlook gets incorporated into nearly ever financial equation via the risk-free rate of return; by shifting the forecasted rate lower, the Fed has taken some of the pressure off the S&P 500 via discounted cash flow models as well as off the more obvious Treasury yields. Let’s start with the low hanging fruit in the Treasury market and keeping it brief with the Ten Year Yield.
The last two jobs reports (and surging equity sentiment) sent the ten year yield shooting higher, back into the 2014 downtrend channel and right through the other side. The FOMC’s latest love letter to bond investors was enough to get it close to the lower boundary, but Treasury yields tend to follow GDP over long time periods and we’re significantly below anticipated GDP for 2015. Some part of this strong move was a relief rally, but are investors setting themselves up for disappointment.
Moving on to equities and looking at the S&P 500 index replicator (SPY) you can see that the market started moving higher on Monday was we closed in on the lower boundary of the ascending wedge pattern that’s been taking shape since last fall. On a daily basis, SPY found support at the 50 day moving average and took off from there with most of the action coming after the FOMC announcement on Wednesday. There was slight selling on Thursday and more buying heading into the weekend although the sellers took over late in the day giving Friday an overall weak feel as we close in on prior support. So why the weak action?
First you have to consider the explicit; rates aren’t rising because the economy is weaker than the Fed would like and no one wants to fumble the economic recovery on the one yard line. GDP is going to fall and depending on Uncle Buck’s trajectory, the broader economy could weaken while corporate earnings are falling due to the currency effect. The second effect we’ll discuss in more depth later this week, but the FOMC’s rate projections are now more in-line with the market (via primary dealers) meaning that valuations didn’t get nearly as large a bump as they could have from falling risk-free rate projections in discounted cash flow models. If the Fed had significantly cut their forecasts, that could have supported much higher valuation estimates.
Uncle Bucks Swan Song?
The second major impact of the FOMC’s projections is on the dollar; everyone went long the dollar expecting the Fed to raise rates as early as June and the fallout has been what you would expect from a mass movement. UUP broke the bump and run formation last week as everyone and their mother decided to close out their two week old dollar positions and enjoy those big fat single digit gains they locked in for themselves.
On a daily basis, you can see there’s strong support at $25.20, giving those who are waiting for a written invitation a chance to close out their positions.
And if the dollar is rising, then the Euro (FXE) must be rising right?
And the rising Euro/falling dollar is giving a lift to unhedged European equity positions as EZU strongly outperformed its unhedged counterpart HEDJ and also cleared another hurdle on a relative momentum basis versus SPY. The falling Euro has been great for lifting European GDP forecasts (and corporate earnings expectations) but remember that the dollar won’t retrace all that ground at once. The ECB is still easing and the Fed is still tightening; the Euro won’t make up all that lost ground and there is still a major shift in investor sentiment to support European equities.
But the falling dollar hasn’t just added lift to European equities; Uncle Buck has been holding down international equities for six months or in the case of the emerging markets for several years, and some of them are primed for a well-earned bounce higher. Consider some of the basket case countries we presented in our special chartology supplement last Sunday (here).
One of biggest winners last week was a country that doesn’t need to use the equivalent of financial training wheels, Brazil, but compare the unhedged and hedged charts before you decided if it was all appreciation by the Real.
Brazil’s currency has depreciated more against the dollar than nearly any other, so even if a good chunk of last week’s action came from rising equities, there could be more currency appreciation to come.
Now what about those countries that need to ride the international version of the short bus? Another of last week’s big winners that the Yinzer Analyst has talked about before is Argentina (ARGT) where the political noose continues to tighten around President Kitchners’ neck, but ARGT continues to barrel higher on improving sentiment.
Then there’s Russia where the reemergence of the new Tsar helped lift RSX, but only the upper boundary of the downtrend channel. As of press time Russia was threatening that naval superpower of the 16th century, Denmark, with potential nuclear annihilation if it participates in the Nato missile defense shield. Not the headline investors like to see heading into Monday’s open.
Finally, let’s consider that asset class that felt most of the sting of the rising dollar, precious metals, where early double digit gains in the first three weeks of January were completely eroded into negative YTD performance heading into last Wednesday. Just to be honest, the Yinzer Analyst is long SLV although he had trimmed his position somewhat in early January. SLV broke out and barreled higher before running out of steam and being denied at the 50 day moving average. There’s a lot of prior resistance/support close to $16.50 so the jury is out on whether this dog has room to run.
Most of that applies to the gold miners (GDX) as well where a strong negative correlation to the Dollar helped the miners recover a lot of the ground lost in March, although they still need to fill the gap and have strong prior resistance ahead of them at the $20 level. But a falling dollar could give the miners the momentum ignition they need to get past that level and back to the 2015 highs.
As of press time the dollar had opened lower but was gaining strength, could it last and for how long? Nothing moves in a straight line and the dollar won’t necessarily lose all that hard won ground in one week, but consider the impact the falling dollar could have on your portfolio and how to position yourself for it.