Stocks bounced back a little overnight, following the Fed-induced selloff from the previous day. The Dow put on 80 points, or 0.4%, while the S&P 500 rose 0.3%.
Gold continued its fall, though; it was down another US$10 an ounce, to US$1,133 an ounce. Silver fell sharply, too, and is now down more than US$1 an ounce, or around 7%, since the Fed’s announcement to raise rates yesterday.
The weakness in the precious metals is all about the strength of the greenback. Yesterday I mentioned that the US dollar index had just hit its highest level since 2003. With another surge in the dollar overnight, that makes it the highest level since late 2002.
You can see this in the chart below. After a big and fast rally during late 2014 and early 2015, the US dollar index traded sideways for nearly two years. But it’s now broken out of that consolidation range and moved to a 14-year high.
That’s a bullish move. Despite the US dollar being a crowded trade right now, there’s nothing in this chart that says the move higher is over. A breakout to a new high is nearly always bullish.
Except the last new high, that is. But, even then, you get some warning signs that the top is in.
[Click to enlarge]
Take the last major dollar bull market for example. The peak occurred in the early 2000s, but the dollar spent the previous five or six years rallying strongly.
This was the ‘new era’ of the tech boom, and the US economy — and therefore the US dollar — was the hottest game in town.
But, towards the peak in big asset markets (like major currencies), things start to get volatile. As you can see in the chart above, the dollar was very volatile as it made three sharp peaks from 2000 to 2002.
The sharp selloff following the third peak (which failed to make a new high) was a strong sign that the top was in. As you can see, we’re at nothing like that stage now.
In other words, this is probably still early days for the US dollar bull market.
But, as I also mentioned yesterday, the biggest risk is the effect that it will have on emerging markets, especially China. As Bloomberg reports:
‘For emerging markets, the Fed just added insult to injury.
‘Its apparent hawkish lurch this week exacerbates the risk that dollar shortages will roil markets from Asia to Latin America next year, analysts warn.
‘“The risks of gray or black swans — negative spill over from the dollar or from U.S. rates upon the rest of the world — was just jacked up a notch,” Martin Enlund, chief currency strategist at Nordea Markets, wrote in a note to clients. “Will global markets positively digest this hawkish message; or will something break? The latter is usually the case.”’
On the contrary, I would argue that the ‘latter’ is not usually the case. While there have been plenty of scares, nothing has ‘broken’ in the eight years since the 2008 crisis.
That doesn’t mean it won’t break tomorrow or next year, but it does suggest that the global economy is more resilient than we tend to give it credit for. We worry about things blowing up a lot, but those worries rarely turn into reality.
Financial markets are volatile. The experience of 2008 was so traumatic, and on such a large scale, that it taught us to associate volatility and uncertainty with another global blow-up. But, the reality is that such an outcome is a low probability.
I was guilty of thinking this way, too. Each selloff was the precursor to ‘the one’ — or so I thought. But, a few years ago, I reassessed. I looked to the market for clues…instead of just following my personal biases.
I began following a stock I called the ‘credit crisis barometer’. I told subscribers of Crisis & Opportunity that, as long as this particular stock price stayed healthy, there was almost no chance of another credit crisis playing out.
That stock was Macquarie Group [ASX:MQG]. And it has just broken out to a new high, as you can see in the chart below.
[Click to enlarge]
Macquarie’s business model relies on plenty of global liquidity and a free flow of global credit. If there is any tightening in credit conditions, you will see it in Macquarie’s share price.
While there may be concerns among analysts about the effect of a rising US dollar on global liquidity and emerging markets, you’re not seeing that concern play out in Macquarie’s share price.
Today’s move looks a lot different to December 2015, when the Fed first raised rates. At the time, Macquarie’s share price looked like it was topping out. It then sold off sharply, as a genuine tightening of global liquidity took hold of markets in early 2016.
While the selloff in the share price was dramatic at that time, it simply retraced the 2015 rally and, therefore, didn’t constitute a credit crisis threat.
And the response to this latest Fed interest rate rise is very different to last year. It suggests to me that worries about a replay of the early 2016 selloff are unfounded.
The message here is simple: Don’t let your biases control your thinking. Look objectively to what the market is saying. The great Richard Russell (rest in peace) had a 60-year career writing about financial markets. One of his most common phrases was ‘follow the money’.
It’s the best advice you can get. Money isn’t biased. It’s amoral. It goes where returns are the highest. Don’t ignore that advice. Following the money tells you that global markets are bullish as we head into 2017.
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PS: Our colleague Callum Newman recently interviewed former News Corporation and Fairfax journalist Michael West.
You can hear the interview on Callum’s podcast, The Newman Show. As Callum told me, West talks about how newspapers are dead, business journalism is a joke in Australia, and no one takes on big end of town.
It’s sure to be an interesting episode.
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