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A divergence between the US equities and US dollar - Part II

Updated: May 6, 2021

We are seeing a divergence in today’s US stock market. What is divergence? It is a situation where two key related index moving away from each other.

This is my observation. The US stock markets continue it’s rally after Donald Trump won the US presidential election in November of 2016. And in the early 2018, it has appreciated 52%. At the same time from the beginning of 2017, the US dollar or the dollar index has been declining… to date it has depreciated 15%.

US stocks moving higher and at the same time US dollar declining, this “divergence”.

In any open economy like the US, when it’s stocks rally, technically, it should have attracted foreign investors to participate. Imagine yourself being a foreign investor, you too wanted to join into this optimism, to invest into US shares. What would you do? Yes, you will sell your currency and buy into US dollar, so as to buy into US shares. Therefore, in a healthy rally, assuming with a good participation by the foreign investors. US dollar should be in demand and going up, however, it is not the case we are seeing today. This rally, in my opinion, it may be driven mainly by the US domestic rather than the global investors, therefore it is standing on sandy ground than a solid rock.

In all studies, there should always be a few variables to support an analysis, I just highlighted one out of a few. There were argument that the weakness of the US dollar is caused by the selling of US fixed income, I do not disagree with that. In fact, the US T Bond prices started to peak in 2016, since then I have been observing the relationship between the 1) Fixed income or Bonds 2) US dollar and 3) US equities. Between them, they usually trend in the same direction. I am believing for the first time in history, we have just observed a continuous uptrend for the US stocks, but a weakening in the US bonds and US dollar. Since the first week of February 2018, the market volatility has started to pick up. Comparing 2017 and 2018, the average daily range has widen significantly.

My observation:

Jan to Feb 17, Dow Jones average range: 106 points

Jan to Feb 18, Dow Jones average range: 362 points

Jan to Feb 17, STI average range: 21.97 points

Jan to Feb 18, STI average range: 30.47 points

Keeping watch on the following in the coming month:

i) Trump’s unpredictable trade policy

ii) Continuous weakening of US dollar

iii) Increase of interest rate - The rate of change or the frequency of rate hike

With constant changes and in order to stay ahead, we need to learn the art of rebalancing or making switches among the different markets.

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