A Historic Inflection Point for the US Dollar

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“With some help from Tariffs and trade war threats, the for the second time since 2015, the Fed blew up the global economy and central bankers around the world are begging for a softer U.S. Dollar policy path. The world’s economy is dysfunctionally out of balance. With a colossal $62T of GDP outside the USA and $18T inside, the Fed cannot conduct monetary policy in a traditional sense. They’re much more of the world’s central bank and June’s meeting will accentuate that point. Their policy actions simply have far too much impact on the rest of the planet. As a result, economists who are myopically focused on U.S. economic fortunes keep embarrassing themselves. At this point, a stronger Dollar will only force the Fed into even more future rate cuts. Stay long gold, emerging markets and underweight US equities.”

Bear Traps Report, June 15, 2019

On Wednesday, the Federal Reserve met and announced they would maintain the current Federal Funds Rate of 2.25-2.5%. This came despite some market expectations that the Fed would cut in June due to weakening global economic data, ongoing trade uncertainty, and dovishness from central banks abroad. Above all, the Fed delivered on the outlook side of the equation. The FOMC dramatically changed its forecast for the future of the Fed policy path, opening the door to interest rate cuts in July, September and even December. With the 2020 election around the corner, the White House needs a lower dollar, and luckily for President Trump, the global economy needs a weak dollar more than he does.

Winners with US Dollar Heading South

Since Late May

Gold Miners $GDX +25%
Silver Miners $SIL +21%
Copper and Steel Miners $XME +17%
Oil $USO +12%
China Internet $KWEB +11%
Emerging Markets $EEM +9%
Oil Production $XLE +8%
S&P 500 $SPY +7%
Financials $XLF +5%

Bloomberg data

US Manufacturing Crushed by the Strong US Dollar
There are a thousand words in this chart. As we witnessed in 2015-16, a strong US dollar hammered the US manufacturing sector and jobs were put at risk. Today, US Manufacturing PMI is essentially in recession territory (a reading below 50 signals recession). A strong US dollar has made exports far more expensive, especially in Europe with their central bank – the ECB – in currency manipulation mode for much of the last 3 years. 

S&P Rose on Fed Cave

Despite the lack of a material change in the fed funds rate, the market reacted positively to the announcement, with the S&P 500 climbing just over 1%  from when the news broke at 2:00 pm to the next day’s open. Chairman Jerome Powell took a relatively dovish tone during his post-meeting Press Conference commentary, in which he acknowledged “moderating” job growth, slowing business investment, as well as inflation beginning to detach from the 2% target. Additionally, the Fed “dot plot”, which illustrates board members’ future interest rate expectations, was revised in a dovish direction, though views are still mixed.

US Dollar, a Trend Break with Colossal Implications
Goodnight Irene, the US Dollar has broken its uptrend which started in January of 2018. This is the beginning of a meaningful leg lower. The Fed has laid a beating on the global economy with eight rate hikes and $666B balance sheet reduction, all since 2016. That’s a colossal amount of tightening compared with the rest of the world. As they unwind this experiment, the greenback is in big trouble. We believe the Dollar is putting in its top, stuck in a dynamic where it’s a victim of its own success. If the Dollar breaks out to new highs, it will find itself in a tricky balance — more global economic destruction and an even greater need to cut rates. A significant weight on the Fed in its recent meetings has been the powerful force in their embarrassing U-turn — the slowdown in global growth and the negative feedback loop back to the U.S. In recent years while the Fed was in crack smoking mode — trying to hike rates and reduce its balance sheet by trillions at the same time — trillions of Dollars ($6T to $7T in our estimates) were sucked back to the United States and the emerging market’s economic engine was the big loser. This giant ocean of capital is about to change direction and Dollars will be pouring out of the U.S.

Fed Couldn’t Stay Stubborn in Face of Global Resistance

With some help from tariffs and trade war threats, the Fed blew up the global economy for the second time since 2015 with its hike late last year. Central bankers around the world are begging for a softer U.S. Dollar policy path. With a colossal $62T of GDP outside the U.S. and $18T inside, the Fed cannot conduct monetary policy in a traditional sense and must accommodate the rest of the globe.

China touts a $13T economy and we hear the Yuan is destined to overthrow the Dollar’s reserve currency status with a mediocre 2% of SWIFT payments now being settled in CNY? What’s the problem with the U.S. Dollar the being the world’s reserve currency anyway? Foreign nations rely heavily on U.S. Dollars for all types of international trade. For instance, if Brazil sells soybeans to Australia, the country “Down Under” will most likely pay Brazil in U.S. Dollars. Because of the reliance on Dollars for trade, Brazil, Australia, and almost every other nation holds loads of Dollar reserves. Most foreign war chests are held in U.S. Treasuries, the world’s safe haven. As global trade has grown over the years, the need for Dollar savings has grown in step and has resulted in more lending to the U.S. Treasury by foreign governments. There are several reasons why a strong U.S. Dollar has evolved into a global economic wrecking ball, and this is one of them.

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Even the Market (Futures) was High Kites
Since September, Fed Funds futures have seen a dramatic shift lower. March 2021 futures have gone from pricing in 1 rate hike to nearly 4 rate cuts. Despite this, until this week’s meeting, the Fed was quite resolute in trying to set up hikes in 2020 and beyond. This is all off the table now, the previous dots were way out of tune and reality has now set in.

Dovish Dot Revision Show Massive Walk-backNine members see no rate cuts this year, eight do (of which seven see two cuts). The committee changed language from its May statement and took out the 2020 rate hike. 

Weaker Dollar Leading to Rotation into Metals and EM

Right now, the market is pricing in a 100% chance of a 25 basis point cut in July and about a 60% chance of a 50 bps cut. As the Fed cuts, the Dollar loses value, and these black clouds of USD weakness are already pushing investors into assets like Gold, Silver, and Emerging Markets (EM). On Thursday, global markets saw a strong reaction, Gold, Silver, and Emerging Markets all soared higher, outperforming the S&P 500. In our view, as rate cuts move from the realm of expectations to reality, these markets will only continue to rally.

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Gold Spiked on Powell Commentary and New DotsThe Fed’s cave led to the largest one-day volatility spike in Gold since Feb 11th, 2016. That day gold closed up 4%, consolidated its move over 2 days then continued its uptrend to a top 4 months later.

U.S. Vulnerable to Foreign Capital Flight

In our view, over the last decade, the U.S. outperformance versus the rest of the world, both in equity markets and in terms of being further along the rate normalization path, led to a flood of foreign capital into the country. However, dovish Fed expectations are causing some of this foreign investment to trickle out. If U.S. growth weakens and equity P/E multiples contract, foreign portfolio flows are going to get uncomfortable and rapidly repatriate capital. A colossal flood out of the Dollar is on our doorstep.

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Semiconductors on the “Other Side of the Mountain”

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What is a reversal formation? It’s where you see distribution after a trend move.  The “Other Side of the Mountain”, or a 1999 style top, is a rare thing of beauty.  It’s the ultimate expression of “fear and greed”; a large group of people, completely oblivious to the reality coming upon them and the rapid transition from FOMO (fear of missing out) to GMO (get me out). There are many kinds of reversal formations, but a classic is the Island Formation. In the US  technology sector, 1999 and 2019 are looking more alike every day. Let us explore…

Land Ho!

Island Formations are rare and news driven. Typically, for an “Island Formation Top”, you would see gappy (short and intense) price action up to a peak, followed by gappy price action down. This is indicative of traders not having enough time to react to rapid news fire. They buy emotionally and then, with a negative change in the news, have to sell right away. This leaves a hard resistance level to overcome ⁠—  “the memory of pain”.  Ideally, one looks for other confirmatory technical indicators. The minimum target is merely the size of the formation itself, but they can be indicative of a permanent reversal of fortunes (for ill or good).

And, as per the above, if the formation happens without a change in the news, it is immediately suspect. Sometimes an island is nice and neat. Other times, however, it probes around a bit and looks a bit sloppy. The latter is what we’re seeing with the SMH Semiconductor ETF. However, individual members thereof had crisper, neater island formations.

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Here is the SMH chart (with detailed commentary below):

SMH Semiconductor ETF — Lookout Below
Part I: The possibility of an island: In April, the SMH Semiconductor ETF enjoyed a parabolic (and, by implication, unsustainable) rise dotted by a plethora of up gaps, indicating desperation to buy. The April 3rd gap was particularly impressive, as there had been a violent up-move day in late March which was immediately reversed in dramatic fashion in the next one and a half trading sessions. The April 3rd gap happened at the peak of that reversal.

Part II: The Prelude to an island:

There had been an uptrend line off the late December/January bottom that tracked nicely with the 50-day moving average. So all looked good until the second half of April. There was a big up day on April 16th, which was followed by a big gap up the next day. After a few days of trading with a peak that failed to hold the highs of the day, we saw a sharp move down on April 25th, then…

Part III: An island is formed:

The first down-gap occurred at the same level as the April 17th up-gap. In other words, an island was formed. The news was reversing quickly: enthusiasm for a deal with China turned into anxiety that one would fail to materialize.

Part IV: Aftermath of the Island top, a new downtrend:

After a tentative move up came to a halt in early May, SMH gapped down again but closed at recovery highs, albeit still down. However, what followed was a negative down-gap the next day and a failed rally attempt the one after…

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Part V: The uptrend breaks down completely:

At this point, true bear recognition that the end was nigh occurred when the uptrend line (in green on the SMH chart) broke. For two days, a noble effort ensued at the 50-day moving average (which latter was flattening out, not good). But all hope was lost the following day with a gap down to 105 and a close near the lows of the day. There followed a meek rally to the underbelly of the 50-day, which was quickly negated by crushing selling below the 100-day and a dramatic gap down. A valiant rally attempt filled the prior day’s gap only to be met with still more selling and a visually meek optimistic close on the 100-day. Then the next day, a gap down followed by yet another gap down the next day.

Clearly, traders were completely whipsawed by the shifting China tariff narrative.

Colossal Rotation is in the Works
A meaningful rotation is in the works here, near historic proportions in our view.  Slow growth consumer staples have outperformed growth stocks in the semiconductor sector by 2200bps (22%) over the last year.

Part VI: Short term base for a short term rally:

Several days of indecision followed this carnage, indicating that 1) ill-considered long positions had been liquidated and 2) a potential trading reversal was in the offing. Sure enough, in early June, we saw the first true solid up day in weeks with a substantial move back up above $100. A touch of indecision the next day preceded a brisk four-day pop that gapped over the 100-day moving average. However…

Part VII: Resumption of the downtrend:

The relief rally ended with a bearish reversal day at the 50-day moving average. This also coincided with the short term reversal top from late March and was roughly at the 50% retracement level of the previous precipitous decline. The next day, it broke the 100-day, though, on the day after, it tested its underbelly. On the third day, however, it gapped down again forming…

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Part VIII: A second mini-island formation:

As a result of today’s gap down, we have had four days of isolated trading at the gap level just below 105. (I excluded the mini-horizontal line in the chart as it clogged up the visual too much…).

In our view, the path of least resistance is down to the $90 area where it had shown support in the late October/mid-November period last year. Lookout below!

Island Formations don’t always work and you don’t always see them. Nonetheless, if the formation fits a violently shifting news flow, as this example clearly does, then the technical analysis and fundamentals agree and we have quickly reversing trade.

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FAANGS, Inequality and Election 2020

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Last week, the Department of Justice and the Federal Trade Commission announced their intention to investigate Amazon, Facebook, Google, and Apple for “anti-competitive behavior”.  In our view, this move is likely at the behest of President Trump in response to a number of Democratic candidates for President, who have become increasingly populist (strict) on “big tech”.  We expect this regulatory and political scrutiny coming from multiple angles to intensify as the election season progresses, which presents significant downside risk for FAANG (Facebook, Amazon, Apple, Netflix, and Google) equities.  It will be a populist political arms race and FAANG equities will be sold as public enemy number one.

The Passive Asset Management Overdose

2019: $7T
2009: $1T

*For every $100B entering passive index funds $16B (SPY) to $48B (QQQ) MUST go into FAANG stocks. The QQQ ETF is 48% Apple, Amazon, Microsoft, Facebook, Google and Netflix – Look Out.

The market concentration in these large-capitalization tech stocks, especially through ETFs, means that when the FAANGs sneeze, the whole market could catch a serious cold.

Combined Wealth of the Top 20 Richest People in the US

2019: $1.05 trillion
2009: $438 billion
1999: $570 billion
1989: $138 billion

Tech billionaires Jeff Bezos (Amazon), Mark Zuckerberg (Facebook), Larry Page (Google), and Sergey Brin (Google) make up a quarter of this $1.05 trillion in wealth. Bezos alone comprises 10%,  even after his $36 billion divorce haircut. In addition, US Financial accounts are now worth 5.3x GDP, significantly more than the 4.7x ratio in 2009 or 4.5x in 2000. Meanwhile, retail store closings are at an all-time high, compliments of e-commerce, and Silicon Valley is drooling over the prospect of autonomous vehicles, which threaten the jobs of the nearly 5 million Americans employed as drivers of some sort.

“Big Tech” Is a Populist Lightning Rod

This has made the FAANGs (Facebook, Amazon, Apple, Netflix, and Google) a lightning rod for populists and they are now under attack from all sides of the political spectrum. Nearly every major Democratic 2020 presidential candidate has promised to investigate potential anti-trust violations by “big tech”. Some like Elizabeth Warren and Bernie Sanders have made plans to limit mega-mergers, what they see as vertical integration, and potentially break some companies like Facebook up central to their campaigns.

Divergence in Consumer Staples vs. FAANGsOver the last few weeks, we’ve seen a divergence between Consumer Staples (XLP) equities and the FAANGs (FANG). This indicates that money is pouring into defensive stocks as investors sense trouble brewing.

Trump and Democrats in Tug of War on Key Voters 

We see the recent announcements out of the DOJ and FTC last week as a response from the Trump administration to populist pressure from the left. The President can direct the general focus of these agencies, and the bureaucrats within them are sensitive to the political considerations of the White House. As the 2020 election kicks into gear, we expect Trump to continue to attempt to outflank his Democratic rivals on the big tech issue — this is just the first inning so get your popcorn now.

In 2016, Trump was able to win over a populist strain of swing voters dissatisfied with their economic circumstances who Republicans hadn’t been able to sway into their camp since Reagan. Many of these voters lost their jobs or had to take a pay cut as a direct consequence of the rise of e-commerce. We’re now seeing a tug of war between Trump and the Democrats over these voters and the proxy issue is big-tech.

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Democrats and Trump Will “One-up” Each Other throughout Election

Democrats are talking tough while Trump is trying to wrench the spotlight back onto himself with antitrust news coming out of the government. We expect this dynamic to intensify as we move into the Democratic debates, or if Sanders or Warren surge in the polls.

Democratic Debates in 2019 Announced So Far:

June 26-27th
July 30-31st
September 12-13th

AMZN, GOOG, and FB Fell on Anti-Trust Announcement Last WeekFAANG stocks had their ninth-worst intraday loss ever on the back of last Monday’s antitrust news (when aggregating their market capitalizations). Facebook was down 7% on the day, while Amazon and Google were down 4.5 and 6%, respectively.  Google also broke a four-year trend channel to the downside – look out below. As the political tug of war escalates, we will likely see more announcements from regulators and more shocks to the FAANGs

FAANGs Dominate ETFs — Markets Beware!

As we noted last July in our blog The Dark Side of FAANGs,  the move into passive asset management (mostly in the form of ETFs) over the last ten years has opened the door to a cascading effect emanating from big tech and its downside risks. In 2009, FAANG stocks were a top 15 holding in just 14 ETFs. Today, that number is over 630.

FAANGs as a percentage of total S&P 500 Market Capitalization

2019: 13%
2018: 11.4%
2017: 10.5%
2016: 8.2%
2015: 7.6%
2014: 6.1%
2013: 5.2%
Market Concentration Creates Vulnerability
The rush into ETFs has created a massive concentration in a select group of large-cap equities, especially the FAANGs and other big tech stocks. According to the Wall Street Journal, in 2019, 85% of total US profits came from the top one hundred largest firms. In 1999, this was only 52% and in 1979, it was a mere 46%.
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Dollars, Elections, and Gold

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For the last five years, the Bloomberg Dollar Spot (BBDXY) hasn’t moved an inch:

June 2019: 1200
June 2018: 1200
June 2017: 1200
June 2016: 1200
June 2015: 1200

The Great Hide-Outs
Today, the crowding in US Dollar assets is the antithesis of the emerging market lovefest circa 2006-7. Prior to the Great Financial Crisis, investors were flooding into emerging markets as US data began to deteriorate, leading EM being perceived as a safe-haven. “They’re building 100 Chicago’s in China don’t you know?” The consensus view was emerging markets had ‘decoupled’ from the US. EM bulls touted that neither Bear Stearns’ collapse nor the struggling and over-levered Lehman Brothers mattered — emerging markets were the ‘safe place’. High kites indeed, last 10 years the S&P is up 267% vs. the iShares China Large-Cap ETF’s paltry 31% for the on a total return basis. However, once the US-born recession washed-over on emerging market shores, the flood of foreign capital rushing back into the US Dollar was colossal. In our view, the opposite dynamic is playing out today. A global trade triggered slowdown is causing investors to hide out in US assets (S&P 500, Treasuries, USD). We believe a capital flood out of the US is on our doorstep.

*Nine Fed rate hikes and $500B balance sheet reduction also had a ton to do with the 2018-19 dollar surge, inflicting pain across a world with over $50T of dollar-denominated debt. Remember, there’s $62T of GDP outside the USA, $18T inside. The Fed essentially blew up the global economy twice in 2016 and 2018 with an aggressive policy path. They’re attrrocious risk managers.

US Economic Risks Catching Up with the Rest of the World? 

We’ve been told time and time again that “late cycle” dollar moves have historically shown strength in the face of adversity — see 2008. Most people forget trillions of US Dollars were hiding out in “decoupled” emerging markets prior to the Great Financial Crisis. A decade ago, thanks to toxic risk assets in the US banking system, investing outside the country in emerging markets was literally considered the “safe haven”.

A decade later, we all know now the decoupling myth didn’t hold. In 2008, capital began flocking back to the USA once the crisis oozed around the world and global economic risks surged. On the other hand, the 2016-19 period has been loaded with global economic risks: currency devaluations, trade worries, and plunging PMIs (purchasing manager indices). As a result, trillions have been hiding out in the USA in technology stocks like the FAANGs (Facebook, Apple, Amazon, Netflix, and Google), passive asset management (over 600 ETFs own FAANG stocks as a top 15% holding), short term US Treasury debt. Downside risks to these assets have surfaced. Today, we’re seeing some major capital outflows from the US — the Dollar is in trouble. Case in point, the yield advantage of short-term US Treasuries (2-year bonds) relative to their German counterparts has moved from 3.55% to 2.55% over the course of the last seven months. From a yield advantage perspective, there are far fewer reasons to hang out in USD.

Elections and the US DollarHeading into the 2020 election, there are few things Treasury Secretary Steven Mnuchin, OMB Director Mick Mulvaney, and of course President Donald Trump want more than a weaker Dollar.  It’s probably not too much of a stretch to say that the Dollar’s 2014-2016 surge delivered Michigan, Wisconsin, and Pennsylvania to Trump on the back of undermined manufacturing and exports (see above, DeadZone). The President clearly knows this and it’s part of the reason for his regular tweets and comments lamenting Powell’s interest rate hikes. USD bulls — beware!

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Gold’s Move Lower into Rate Hikes
As rate hikes go, gold has plunged into every single one of them since 2015. Today, the investors are obsessed with rate cuts coming down the pike, we’ve come a long way, baby. The probability of a Federal Reserve interest rate cut this June has moved from just 5% to 30% over the course of the past week. Now that investors are anticipating a total 180-degree turnaround from the Fed, precious metals are surging on the prospects of central bank love and accommodation. Thanks, Jay (Jerome Powell, Chairman of the Fed Board of Governors)…

Stimulus in Europe and a Buoyant Euro

One development we see going forward is a US focus on monetary policy due to gridlock in Washington. At the same time, the rest of the world (RoW) is shifting toward the fiscal side. Today, in Europe, we’re seeing Deputy Premier Salvini — de facto the most popular political force in Italy — pushing a flat tax and massive deficit spending despite EU rules. Meanwhile, Germany is likely heading toward a fiscal stimulus package focused on infrastructure to make up for lagging growth in manufacturing and Southern Europe’s economic woes. Recent elections, especially those to the European Parliament — in which populists increased there vote share from 21% to nearly 30% — have shocked European leaders. As Europe’s economic engine, Germany led by Chancellor Angela Merkel is desperate to keep the economy humming along by any means necessary so as to avoid continued populist success at home and across the continent.

Fed and ECB Policy Will Run Gold Wild vs. StocksGold just loves a good Fed cave-a-thon. Take a look above at its remarkable performance against the S&P 500 during rate cutting and hiking cycles. We see more love coming for the gold bulls versus stocks.

Fast Money Approaching

Fed monetary policy expectations and fiscal stimulus out of Germany and Italy are clearly a Euro positive and thus yet another USD negative. From a technical analysis standpoint, gold has to get above the $1375 per ounce mark convincingly in order to break the back of its near decade-long bear market. After that, silver junkies will join the party and it all goes hyperbolic. To be continued…

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