We are experiencing a very important market event this month, as the US dollar is breaking through a significant long term support. Such a move, if sustained, is very important for market participants because the USD is one of the most important asset class in macroeconomics. I can give many reasons of the utmost importance dollar has in the global economy, like it being the world reserve currency, but it is not the subject of this article. In the next few lines, I would like to review some strategic implications implied by this important market event, and give a trade recommendation in conclusion.
First, let’s take a look at a 5 years chart of the US Dollar Index:
During the past 2 years and a half the strong support I am talking about (in green) supported price no less than 6 times. In technical analysis, the longer a support hold and the more times price rebound from it, the more significant it is. A break of that important support should not be taken lightly by market participants in the face of its potential market forces.
A weak dollar has many inter-market resonances of which the most important one is for me its impact on commodity prices. Due to many of them being priced in dollar terms, a strong inverse relationship exist between the two assets.
As can be seen on the chart above, the CRB commodity index broke out of its recent 3 years downtrend last February. A dollar breakout will therefore be further evidence confirming this nascent uptrend.
In addition, it is also important to understand that a falling USD is bullish for the relative performance of foreign stocks (see relative performance of the iShares MSCI EAFA ETF vs USD in the chart below). The prevalent under-performance to US stocks before this year stopped, but have yet to decisively turn the other way. I expect this important USD breakout to be the catalyst for a foreign stocks out-performance.
Combining all the above, countries that produce commodities stand to benefit even more from a weaker US Dollar. Not surprisingly, we have seen developed countries commodity producers like Canada and Australia see their stock markets hitting new multi-year highs lately. But from a contrarian point of view, I am very interested in Brazil, another big commodity producer, that have been beaten down lately by the negative sentiment surrounding Emerging Markets in general.
Technically speaking, the iShares Brazil ETF (EWZ) is strong, breaking out of a triangle consolidation pattern to the upside. Since the start of last month, it is performing better than the S&P500 on a relative basis which is confirming the thesis presented above.
I believe it is a smart idea to begin or to increase exposure on this market as long as the USD is confirming its downtrend.
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