On Tuesday morning, Bloomberg featured an article entitled The Great Debasement Is Rippling Across Markets. From the start of the year until its low in the middle of September, the US dollar index fell by nearly 15%. The weak dollar seems to fuel the debasement narrative, benefiting a few asset classes. The most obvious assets benefiting are the precious metals, with gold and silver up 50% and 75% year to date, respectively. Not in the “debasement limelight” like gold and silver, but also outperforming are foreign stocks. The negative correlation of foreign stocks and the dollar has proven robust this year.

To wit, the iShares Foreign Developed Markets (EFA) and Emerging Markets (EEM) ETFs have risen by 25% and 29% respectively, year to date. For context, the S&P 500 is up about 15%. Bear in mind that over the last five years, domestic markets have significantly outperformed foreign markets. Over the last five years, the S&P 500 has been up 95%, compared to 43% for EFA and 17% for EEM.

This leads to an important question: if the dollar reverses higher, will the negative correlation weigh on foreign stocks? Our bet is yes. In other words, enjoy the rally in foreign stocks, but don’t lose sight of the fact that fundamentals do not support the trade. Importantly, dollar correlation works both ways. The graphs below show the strong negative correlation of EEM and EFA to the dollar. The price axis of the two ETS is in reverse order to better highlight the relationship. The bottom graph in both graphs is the 50-day correlation.

We leave you with a counterpoint of the debasement narrative from the Bloomberg article:

“Whoever thinks currencies and bonds are replaceable with bitcoin and gold needs a reality check,” said Shoki Omori, Tokyo-based chief desk strategist at Mizuho Securities Co., one of Japan’s biggest brokerages.

Omori thinks markets are just witnessing a “momentum trade,” in which more and more investors pile into a seemingly winning trade regardless of fundamentals.

What To Watch Today

Earnings

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Economy
 

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Market Trading Update

Yesterday, we discussed the short-term risk of Friday’s pullback, potentially failing, into further corrective action. On Monday, the market did just that as it rallied to the 20-DMA, which was broken with Friday’s decline, but failed to move above it. Then yesterday, the market sold off and retested the 50-DMA on the open. From a bullish perspective, retail investors continue to step in and “buy the dip,” allowing the market to rally off support. The question, however, is whether there will be follow-through enough to get the market back above the 20-DMA before the end of the trading week. Should the market fail to regain the 20-DMA, the risk of further consolidative or corrective action increases. As shown, the 50-DMA is key support for now, but the 100 and 200-DMA are the next critical supports should the market break down from here. Notably, the MACD has triggered a sell signal, and relative strength is still correcting previous excesses.
 

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While our commentary over the past couple of weeks, warning about risk management, was monotonous as markets incessantly rose, these breaks make the actions necessary. While we are still bullish into the end of the year, we suggest not overreacting to the current market action. Given the current sentiment/momentum backdrop, combined with corporate buybacks and the need for professional managers to catch up on performance, our best guess is that the market will be high by year-end. While buying on current weakness is likely a good idea, I would also be mindful of balancing any speculative exposure with a defensive offset. There is indeed risk to the market, and you don’t want to get caught flatfooted if something breaks.
 

JPM: Good Earnings But…

JP Morgan (JPM) posted a solid earnings report, but based on its stock price, shareholders are not optimistic. JPM opened down by over 4% despite its EPS beating estimates by 5% and revenues by 3%. Here are a few reasons why JPM shares are trading lower.

Rising operational costs and credit concerns: Investors seem to be expressing caution about increasing expenses and credit costs. In turn, rising expenses and loan losses raise the question of how sustainable its profit margins are.

Profit taking and Wall Street analyst downgrades: Some banks and brokerages downgraded their ratings. For example, Oppenheimer cut JPMorgan from “outperform” to “market perform”, and Morgan Stanley downgraded it from “overweight” to “equal weight.” After the stock’s 30% year-to-date gain and nearly 40% increase over the past 12 months, investors may be taking profits on the news.

Economic outlook: While the company beat earnings expectations and had a reasonably optimistic outlook, its CEO, Jamie Dimon, does offer a cloudy macroeconomic outlook. Per Jamie Dimon:

While there have been some signs of a softening, particularly in job growth, the U.S. economy generally remained resilient. However, there continues to be a heightened degree of uncertainty…

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