Wonky Wednesday

Above 40,000 feet, we can begin to see the curvature of the earth and gain a better sense of the interconnected whole.  A standout feature from this vista is that though their paths may change sometimes, rivers always reach the sea*.   We use this analogy to view the impact of central bank policy on the markets, starting with currencies.  Viewing central banks as distorting the landscape, the interrelationships between rates, currencies, credits and equities have created different routes for the flow of funds.  Until recently, there are traders who have spent their entire careers shorting the dollar and using the proceeds to buy other securities, only to find small shifts in one or two variables result in a flood of money flowing downstream to fill margin calls.

A wonkier discussion with an Austrian School perspective was recently published http://www.nber.org/papers/w20771#fromrss (HT to the FT).  What’s interesting is the author’s attention to the business cycle.  Our view is that it remains important because while markets may change, investor behavior does not, and peaking cyclical performance aligned with what may be a peak in credit availability has implications for investors.

Currently the EUR/USD is breaking support and its origin price of 117, and is at risk of testing 105 if it can’t reverse back up by month’s end.  Swiss rejection of a proposed gold standard resulted in a trend line breakdown in the CHF/USD.  Sound money India has the INR/USD advancing, while the USD and JPY are testing respective resistance and support levels.  Since 2011, commodity-oriented country’s  currencies have followed their key exports lower.  The AUD/USD and CAD/USD are now nearing support.  If one is not convinced of overcapacity and malinvestment keeping a Chinese recovery at bay, the uptrend in the GLD/CRB chart makes a strong case for global slowing.  A breakout to the upside for the US dollar likely forces more pair trade unwinds and a reduction in leveraged positions, similar to what we’ve seen in oil (Oil, Equities and Leverage), and it is implied that this would further pressure the S&P 500.  At a minimum, these would be headwinds, since absent a viable alternative for yield-seekers, equities remain the only game in town.  Given all these shifts in the charts, we are always struck by technicians referring back to the fundamentals when there is a disruption, and on that point, the upcoming earnings season carries more potential for volatility than the past few have.

Our recent review of cyclical performance shows a number of sectors’ profit margins at or near peaks and this bears watching.  Consumer Discretionary, Consumer Staples, and especially Technology exceeded prior cyclical highs.  Technology’s profit margins now appear to be post-peak.  Interestingly, while the broad market’s profit margin exceeds the prior cycle, the other seven sectors have yet to reach prior peaks.  Healthcare is three years into recovering from its recent trough (this exceeded the prior cyclical trough).

Within the IT sector and closer to the ground, the relationship between semiconductors/NASDAQ suggest semi’s may have bottomed.  In the context of the Information Technology sector consolidating, our measure of sector relative strength has been slowly improving for semi’s at the expense of electronic hardware and services, and this improvement is even more evident for software.  Should support for the broader sector hold, semi’s and software could provide for relative out-performance.

Please contact us for further discussion or detailed charts.

The exception to the reference at top* is the Okavango river.

Steven Charest

Managing Director, Chief Market Strategist