By Gavekal Capital Blog
Regardless of the series you use, the USD seems to have broken out of a 20-month trading range and is trading at the highest level in well over a decade. Over the past 10 years, there have been some strong equity sector relationships with the USD. Since this summer, some of these relationships have moved in an inverse direction to historical correlations.
This means that either previous relationships are no longer valid or we should expect to see some "reversion to the mean" in the near future. As we like to say, our crystal ball is no better than anyone else's, so we present these charts with minimal commentary regarding the future direction of the market.
As regular readers know, we like to break the equity market into 5 baskets: early cyclicals, late cyclicals, hyper cyclicals, growth counter-cyclicals, interest rate sensitive counter-cyclicals. The most tightly correlated basket to the USD over the past decade has clearly been late cyclicals (energy, industrials, and materials). This basket has underperformed the overall GKCI DM equity index by nearly 27% over the past decade. It is noteworthy that this group has basically market-performed since the election while the dollar has gained by roughly 3%.
Early cyclicals (consumer discretionary) have had the highest positive correlation to the USD over the past decade. So as the dollar strengthens, early cyclicals have outperformed the broader market. Again, similar to late cyclicals, early cyclicals have broadly market-performed while the dollar has picked up steam.
Growth counter-cyclicals (consumer staples and health care) and the USD have been going in opposite directions since this summer. Growth counter-cyclicals have underperformed the broader market by over 11% since 7/7/2016 while the dollar has strengthened by nearly 5%. This is a breakdown from the usual relationship over the past decade as these two series still have a 70% correlation.
Lastly, for hyper cyclicals (financials and information technology), there hasn't been a very robust relationship to the dollar for the past decade. The 10-year correlation is just -20%. We would highlight that while hyper cyclicals have outperformed the broader market by nearly 10% since 7/7/2016, hyper cyclicals have not broken out of the trading range that has been in place since 2009. While the relationship to the USD hasn't been very strong, hyper cyclicals have had a very tight correlation (82%) to the Chinese yuan.
The yuan has already depreciated over 6.3% against the dollar this year and is trading at its weakest levels against the dollar since 2008. If the yuan depreciates another 6.3% in 2017, this would put the yuan per dollar exchange rate at 7.33 which would be the weakest level since 2007. This will be worth watching and could help to determine if the outperformance of hyper cyclicals is here to stay for the foreseeable future.