Beware of the interaction between currency and stock markets

Beware of the interaction between currency and stock markets

The US dollar (USD) had a strong year against most currencies around the world. In this article, we explain this decision and its impact on global stock markets. The rise in the USD coincided with economic weakness in many foreign countries at a time when the US Federal Reserve was raising interest rates, which in turn fueled demand for US Treasuries and US currency. . Recently however, the trade-weighted U.S. dollar (against a basket of developed market currencies) has fallen sharply on weaker-than-expected Consumer Price Index and Price Index results. to production. This caused long-term US bond yields to fall and the US dollar with them. As shown in the DataGraph™ below, the US Dollar is testing its 200-DMA, which it has remained above since June 2021.

Daily trade-weighted USD (against euro, pound, yen, franc, koruna, Australian dollar), July 2021 to October 2022

Looking at a longer-term Monthly DataGraph below, the US Dollar has seen a substantial rally from its 2021 lows to its recent highs, appreciating by around 28%. The dollar’s short-term top was confirmed by lower highs in October and early November, and then a strong break down of the 50-DMA last week. Given the magnitude of the upside and the sharpness of the recent breakout, it is possible that the Dollar may form a longer-term top, although it has yet to break through long-term support.

Monthly trade-weighted USD (against euro, pound, yen, franc, krone, Australian dollar), 1993 – 2022

It is important to note the effects of currencies on global stock markets. Most of the USD rally started in early 2022, coinciding with a spike in many global markets. Often, the strength of the US dollar leads to relative underperformance in foreign stock markets, especially emerging markets. This situation is exacerbated for US-based investors who hold foreign funds, as USD-based ETFs are hurt by the rising dollar. The last multi-year period of US dollar weakness (2002-2007) coincided with strong global market outperformance (in USD terms) and was particularly true in emerging markets. Thus, the rise of the dollar contributes to the relative outperformance of the American stock market.

Year-to-date (YTD) and during the recent USD spike, the damage to other currencies has been widespread, as shown in the chart below; some of the hardest hit have lost between 8% and 20% year-to-date through September. The only major currencies relatively spared were the Brazilian real and the Mexican peso.

The combination of a peak in local stock markets at the end of 2021 followed by a depreciation of the currency against the US dollar has resulted in an average drop in these foreign stock markets of 25% since the beginning of September in US dollars. The only markets (using popular ETFs as a proxy) that did not drop at least 20% were Brazil, India, Mexico and Thailand, as shown in the chart on the next page.

Evolution of certain non-US global stock markets and currencies, from 12/31/2021 to 09/30/2022

However, the past six weeks have seen a big turnaround, with USD-traded foreign market ETFs rallying sharply as oversold underlying equity markets and foreign currencies strengthened.

Selected global currencies against the US dollar, from 09/30/2022 to 11/17/2022

The Vanguard Total Intl Stock Index ETF (VXUS
). It reacted to the weakness in the US dollar and rebounded around 15% from its September low, resulting in a good relative performance against the S&P 500.

However, although VXUS has already attempted to bottom out in relative terms, it has been unable to break the decade-plus downtrend of relative strength (RS) lows against the S&P 500. While current ex-US ETFs did not exist until 2008, the last time global markets maintained an outperformance (more than 2-3 quarters) against the US was during the USD bear market and the broad non-US rally from 2002 to 2007 (see USD monthly chart above).

Vanguard Total International Stock Index ETF, December 2015 to September 2022

At this point, it is too early to expect another period of sustained outperformance in overseas markets and US dollar weakness. In fact, global markets and foreign currencies still have a lot more to prove than the dollar and US market, still the long-term leader. Currently, the odds are still against the prolonged underperformance of the US dollar and equity markets. But, if we’re looking for ways to invest in this potential, we like international markets leading this short-term rally around the world. Specifically, these are Italy, Germany, France, Korea, South Africa and Mexico. These markets have risen 15-25% in US dollars over the past six weeks and are either above their 200 DMAs or testing the bottom.

Performance of the Focus Foreign Markets ETF, January 2022 to November 2022

A few key themes that have helped foreign markets take the lead in the near term include luxury goods in France and Italy; manufacturers in Germany and Korea; Banks and Real Estate in Mexico; and Retail in South Africa, among others.

Other markets to consider potentially include Japan, which has seen a less recent rise but has strong momentum in terms of performance in capital goods, consumer cyclicals and technology; India, which is also less up but is a long-term global leader with strong participation from the technology, basic materials, financials and consumer sectors; and China/Hong Kong, which has been in one of the most bearish stock markets and for a much longer period than most. This market is beginning to show the emergence of new leadership in the healthcare, capital goods and consumer discretionary sectors.

If there is one clear winner from the decline in the US dollar, it is global industries. The iShares Global Industrial ETF (EXI), which seeks to track the S&P Global 1,200 Industrials Sector, is a great way to track the global space. It is 55% weighted to the US market, but this is significantly less than the US weighting for global indices with all sectors. It contains holdings from 18 countries with significant weights in aerospace/defense, machinery, building products, construction, outsourcing/personnel/market research, diversified operations, electrical equipment, pollution control, airlines, logistics and ships/rails. From the weekly DataGraph below, the strong relative performance over the past two months (coinciding with the top of the US Dollar) is quite clear, with the RS line (versus the S&P 500) peaking since the start of the year this month. The sector is well above its 40-WMA and close to a test of its August peak, driven by strength from the US, UK, Japan, Germany and France , among others.

iShares Global Industrials ETF, December 2015 – September 2022


Although we always recommend that investors invest the majority of their stocks in the United States, we want to remain attentive to a possible change in trend towards foreign markets. In this regard, we will be watching recent relative weakness in the US dollar and stock market for signs that it is time to take more aggressive positions overseas. We’ll also be keeping an eye out for other clues about what might join industrialists as the next big area of ​​leadership.


Kenley ScottDirectorresearch analyst William O’Neil + Co., Incorporated

As the firm’s global sector strategist, Kenley Scott provides his perspective on the weekly sector highlights and writes the global sector strategy, which highlights emerging thematic and sectoral strengths and weaknesses in 48 countries around the world. . It also covers the global energy, basic materials and transportation sectors and holds a Series 65 securities license.

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