Saturday, February 13, 2016

S&P: Last General Standing

This global bear market has been going on in stages:  first the front line privates (China, emerging markets) were the ones getting mauled, in August and September.  The low hanging fruit for the bears.  Next came the junk bonds, in December, which are the corporals and sergeants.  Then you have the small cap stocks, which are a motley crue of privates, seargents, captains, and majors.  They have been lagging the large cap stocks badly for over a year.

Now you are hitting Europe and Japan, which are the captains and majors.  Europe and Japan are more reliant on Chinese imports than the U.S.  In fact, the U.S. has the least to lose and the most to gain from a Chinese devaluation and weakening Chinese economy.  

The last man standing, are the generals:  the large cap U.S. stocks.  They are the ones that are considered the least risky on the global equity risk curve.  And for good reason:  they have adopted the most shareholder friendly policies by buying back tons of stock and their profitably has been growing while those in other countries have not.  It helps that many of these U.S. corporations are virtual oligopolies with fat profit margins that seem to keep widening.

What you saw this past week was the market being offsides betting on the strong dollar theme.  If the Fed doesn't tighten, and will have to enact a rate cut later this year, that kills the strong dollar trade.  That ignites a run into Treasuries, and for the more speculative, gold.  This weaker dollar really hurts Europe and Japanese equities, because those rallies were built on a thesis that the dollar would continue to get stronger.  But that became too consensus, and quite frankly, the dollar just got way too expensive.  Now that both value and momentum are on the side of dollar bears, you get explosive selloffs in the dollar vs euro and yen.  This is a boon for large cap US stocks, which were feeling the pain of a stronger dollar in 2015.  S&P 500 is the last general standing in this global equity risk pyramid.

When you find most macro fund managers are underweight US and overweight Europe and Japan, it just pours gasoline on the fire of US equity outperformance.  This is in the early innings, this newfound dollar weakening.  It should be a major catalyst for the moves in the coming months.  If you have to short anything, short Europe, Japan, and China.  And if you want to go long, the best one is the strongest:  S&P 500.

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