Despite a global pandemic, we are living in an age of optimism. Recent sentiment indicators have not just been ticking up, many are actually at record highs. One of the sentiment indicators is the purchasing managers index (PMI).

Put simply, PMI is a global measure. It serves as a leading indicator of whether economies are accelerating or decelerating. A PMI above 50 means economies are accelerating and a PMI below 50 means they’re contracting (for a more detailed explanation, click here). As we’ve mentioned in previous pieces, the pace of global recovery is a story of haves and have nots (see Rise of the Variants), as indicated in the map below.

Global PMI Heatmap

An age of US exceptionalism – looking tactically mature  

The pace of US recovery has been much faster than the rest of the world. It is reasonable to use higher frequency PMI data as a leading indicator of GDP growth.

US vs Global PMI vs GDP Chart

Markets and asset prices are built on expectations. Equity markets in the US have been running significantly hotter than most other geographies. Some of this is related to the fact that US indices tend to have a higher weighting to tech. Tech stocks have been leading the charge more recently.

Below, we map the relative performance of the S&P 500 against the Eurostoxx 50. We can see that this relative ratio is looking largely extended over a multi-decade timeframe.

SP 500 vs. Eurostoxx 50 ratio

Over a shorter time period, it is interesting to note that movements in this ratio tend to correlate with underlying movements in the overall value of the US dollar.

SP500 Eurostoxx50 ratio vs Dollar index

However, these seem to be concurrent indicators. So, let’s look at another ratio which may prove more instructive. The performance of the Dow Jones industrial index against the S&P 500, compared to the overall value of the dollar index is a good measure. We can see that equity markets tend to preempt movements in the overall value of the dollar. The scope of this piece is not wide enough to go into specific issues around causality vs. correlation. However, the overall trend is certainly interesting.

Dow/SP500 ratio vs the Dollar Index

As such, if this period of US equity exceptionalism in financial markets has run a little ahead of itself, it would stand to reason that the relative performance may ease back. (In case you missed it, check out my recent podcast, European Gems). In the event of this happening, we may incidentally see short-term tactical strength in the US dollar reemerge.

Other global macro indicators – looking up

However, underlying macro indicators (like the Baltic Dry index) which tracks the cost of shipping dry goods around the world, have started to rear their head, after almost a decade of lackluster range bound performance.

Chart of the Baltic Dry Index

As such, the longer term prognosis vs. the short term tactical prognosis may vary.

Now why is this important? All global commodities are currently priced in U.S. dollars. The US dollar has served as the global reserve currency for almost a century. I have previously written about how “It’s all about the dollar”. Most recently a weak dollar has proved supportive of global commodities prices.

Of particularly interest is the global price of copper. Copper prices have rallied from levels of around $2.00/lb. to current levels of around $4.50. Now there is a sound fundamental basis for this rally in copper. Copper’s demand in construction, electronics, as well as the most recent push for clean energy and EV’s are all supportive of underlying demand.

Copper futures price

Copper has always served as a leading indicator for global growth. However, a rally of over 50% in just a few months, may give rise to sum pause and caution. Lumber prices have exhibited a similar trajectory. We wrote about this a few months back when discussing our risk flags. Even a generalized measure of commodities (like the CRB index which includes some energy as well as soft commodities), has risen from around 100 index points in 2020 to almost 200 index points currently.

Chart of the CRB Index

These indicators have given rise to concerns around runaway inflation. Whilst they are certainly concerning, because CPI or PCE are generally seen as rates of change on a year on year basis, I am a little less concerned that inflation will be sustained. (See Inflation Consternation). It is however a risk flag on the horizon which warrants careful consideration.

Commodities boom – EM Boom

Back to the commodities story, stronger commodities pries have been very supportive of EM currencies and terms of trade. The correlation between the USDZAR and CRB index for example is clear. This has resulted in some pretty decent performance in many commodity exporters current accounts. This has certainly been a boon in such trying times.
Chart of the CRB index vs the USDZAR

Over the short term, I believe that the US dollar may resume a tactical up leg. This could be anywhere between 4-10% stronger than current levels. A stronger dollar tends to correlate with periods of ‘risk off’ in high beta assets like EM FX and/or equities. Equities are currently riding a tailwind of strong earnings reports. As such, the timing of any correction would likely be contingent on seeing through the earnings season.

So what next?

That said, the longer-term prognosis for the world seems one of stronger growth. Optimism is strong as vaccines continue to be rolled out and as more and more geographies are opened up. This may give rise to a surge in pent up travel and spending. (See my article for Finweek: Let’s head down to the BEACH).

Could we see a stronger dollar and stronger world growth? Yes, it is possible. This may manifest itself in a relative underperformance of US markets compared to other major bourses without any large scale absolute sell off.

The devil is always in the detail. It is why it is so important to maintain a longer term lens and plan when considering one’s own investment strategies and asset allocation. And that’s because even in the depths of despair, human ingenuity will emerge, perseverance will take hold.

Perhaps that’s just the optimist in me thinking that every cloud has a ‘copper’ lining.



0 CommentsClose Comments

Leave a comment

Social media


Our content is intended to be used and must be used for informational purposes only. You must do your own analysis before executing any investments or strategic decisions, based on your own circumstances. We do not provide personalised recommendations or views as to whether an investment approach or corporate strategy is suited to the needs of a specific individual or entity. You should take independent financial advice from a suitably qualified individual who gives due regard to your personal circumstances. Whilst every care is taken, we accept no responsibility or liability for any errors or omissions in any of our content. The views, thoughts and opinions expressed in our content belong solely to the author or quoted individuals and/or entities, and not necessarily to the author’s employer, organisation, committee or other group or individual, or any of our affiliates or brand partners.

Moe Knows © Copyright 2024. All Rights Reserved.