Cash Chronicles is coming to you this week from Texas, where the prospect of doubling down on the US and especially it’s housing market, are becoming an alluring prospect. In this post, I would like to look back at my strategy I laid out for equity markets a little over a month ago called Dollar Bear, Value Bull, which predicted a continued decline in the dollar versus other currencies as well as further outperformance of value shares versus growth shares.

The market seems to have heard this notion and trashed it, going the complete opposite way. Global shares didn’t decline, but they failed to keep pace with US large cap indexes like the S&P 500. As seen through the Vanguard ETF’s which track the FTSE Global All Cap Index (VT) as well as the Vanguard Small Cap Value Index (VBR), both have underperformed the Vanguard S&P 500 ETF (VOO). These first two ETF’s returned 5.4% in the last month compared to 7.2% for the S&P 500.

Likewise the dollar index has strengthened, confounding a Wall St. consensus forecast that the dollar was set to decline in 2021 due to a dovish central bank as well as massive fiscal stimulus that would be flooding the world with dollars.

International Performance

For the international performance there were two main weaknesses that became more apparent in the last month: the slow rollout in vaccines and how the market digested higher long term rates in the US.

All the stimulus in the US has seemed to not only flood the world with dollars but pushed up the growth forecast for the US. Faster growth in the US could mean tightening sooner, sending rates higher sooner and helping push the dollar up. The Euro zone and Japanese recoveries are now expected to underwhelm, this would likely keep their currencies weak against the dollar with little room to raise rates.

These weaker recoveries now seem to be held down by slow rollout of the vaccine in Europe. The pause in Astra Zeneca vaccines due to some who had clotting issues as well as the lack of multiple vaccine options are weighing on the block.

Besides advantaged economies, emerging economies also found themselves underperforming the US over the last 4-6 weeks for many of the same reasons as well as some different ones. The rise in the long end of the rates curve in the US seems to have impacted rates in the emerging world and have hurt the “risk on” narrative that expected emerging economy stocks to outperform this year. The IMF produced an overview of its view on how the US curve affects emerging economies and their explanation was a bit underwhelming: higher rates can be good or bad. Their rationale is as follows:

• When the rise in rich world rates is driven by a hawkish central bank – this tends to hurt inflows into emerging economies – each rate surprise in advanced economies raises real long term rates by a third in emerging economies.
• If higher rates are due to greater growth then this is good for emerging market economies – the growth in advanced economies could then lead to an increase in exports and incomes in emerging economies.
• Inflation has a benign effect – they speculate it is because inflation surprises contain a mix of good economic news like greater growth along with bad news like higher producer prices.

This really tells us nothing because it leaves us to guess how the market perceives the rates rises, which tends to be subjective depending on the observer.

Whatever you believe, the recent changes in the term structure of US rates likely helped to produce an outflow of funds from emerging markets over the past month which has hurt returns in shares.

Value Underperforms

Even if we were to stay in the US however, value investing was another theme that was supposed to dominate 2021. This was supposed to be the year we finally saw value overtake growth and experience some mean reversion towards its rightful place as one of the strongest investing strategies.

Yet the value strategy right now tends to be more heavily weighted towards energy and financial stocks, which have increased in value over the past month but still have not managed to capture the potential consumer boom that a rapidly growing US economy could see. It may be one reason why the consumer discretionary sector continued its outperformance over the past month and beat out value returns as well as those of the overall index.

Given these developments, I still think the fundamentals underlying a long term dollar decline as well as value outperformance exist, but I have trimmed my bet on them happening now. At least some of the proceeds will be spent on the US housing market, specifically home builders, which I don’t see anything stopping their rise except for a short term supply bottleneck in lumber prices.

As I keep a busy schedule for the next month I will be cutting the length of my posts in half but will keep readers updated of my thoughts on current events and the markets, as well as how my market views play out. Stay tuned.

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