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Macroeconomics and the US Dollar

|Includes: iShares MSCI EAFE ETF (EFA)

I have two charts for your perusal tonight, dear readers – focused on the broader indexes.  Tonight my thoughts go to my TSP allocation, specifically: my over weighting of the international index (the EFA).  This international index will tend to have a bit more volatility than the S&P 500, similar to the Wilshire 4500 (EMW) – but decorrelated at times.  Lately, the EFA and EMW have been rather decorrelated.  Much of this is due to the economic worries in Europe, as the PIIGS national economies (Portugal, Ireland, Italy, Greece, and Spain) have really shown how shaky this debt/leverage house of cards can be.

Exchange rates also have much to do with the relative performance of the EFA and US indexes.  As the value of US currency goes down (and o-how-it-has since 2000), the EFA will get a corresponding tail wind due to the greater currency valuations it represents.  Now lest you think this whole post is just a bunch of hand waving and pie in the sky economic mumbo-jumbo, I offer my first chart: hard core technical analysis of the EFA point and figure chart.  What I’m showing here is an equity clearly being owned by increasing demand that overpowers supply.  Prices can not increase without more buying interest than selling interest – and this chart demonstrates that in spades.  Fair enough, we should expect higher prices on the EFA and I’m happy to hold my investment there.

The natural follow up question is, “will the EFA outperform domestic indexes?”  That question I hope to answer by means of my second chart, showing the value of the US dollar on a weekly candlestick chart.  This proves by observation my earlier premise – that declining value in US currency boosts the performance of the EFA vs the EMW or SPX.  Notice especially the blue outlined timespans: when the US greenback falls, the EFA was killing versus the domestics. Now granted, my chart note about a possible top forming is speculative – but it does fall in line with a descending channel.

I think the more compelling argument for decreasing value in the US dollar is in the headlines.  You may have heard of quantitative easing, which is how my government has chosen to try to stimulate the economy (it really just means printing more money that didn’t exist before – I wish I could do that).  Contrast that with the austerity measures being imposed overseas, and I think it’s a safe bet that there is room for the value of the dollar to fall further.  Bottom line – although the EFA has underperformed the domestic indexes lately, I expect that those roles will reverse.

Disclosure: I am long EFA.