At this time of year, one of my favourite aspects of the festive season is a visit to the pantomime, a show for all the family with its host of classic characters. What would the Fairy Godmother or the Genie of the Lamp grant an investor as their Christmas Wish 2016? And what would help us most in terms of helping our clients? There are various political candidates of course, perhaps the winner of the US Presidential election next November might be one, or the outcome of a Brexit referendum in the UK. An equity strategist might ask for the sectors with the widest dispersion, a commodity strategist might ask for information about the price of oil.
So what wish would I ask to be granted? It would have to be the answer to the question: where does the trade weighted US dollar index move over the course of the coming year? The trend will tell us a great deal about what is happening in the real economy, commodity prices, Fed tightening, company profits and emerging market stresses and strains.
I should emphasise, of course, that concentrating on one single number only works if a variety of asset market / real economy correlations remain in place for 2016 as they have in 2015 – that it is not different this time. For example there has been a close relationship between the rise in the US dollar and the weakness of commodity prices traded in dollars. A sharply higher US currency in 2016 would lead to further pain for commodity producers across the world. As the US currency has become progressively less competitive, so this headwind puts pressures on profits from US firm’s overseas operations, an important driver of the steady drumbeat of US earnings downgrades reported by analysts. Perhaps most important of all is how the rise in the US dollar ties in with a general tightening of global monetary conditions. Only a few days ago we had another warning from the Bank for International Settlements that it was very concerned about emerging markets. To quote Claudio Borio: “Financial vulnerabilities have not gone away. The stock of dollar-denominated debt, which has roughly doubled since early 2009 to over $3 trillion, is still there. In fact, its value in domestic currency terms has grown in line with the US dollar's appreciation, weighing on financial conditions and weakening balance sheets.”
Our House View continues to prefer developed to emerging market assets against this backdrop.
Andrew Milligan, Head of Global Strategy, Standard Life Investments
First published in Citywire Wealth Manager 14th January 2015