The USD is moving lower. If this persists, which, based on our research, seems likely over the next 6-12 months, this should prove to be a tailwind to SP500 earnings.
Seeing stocks down when the USD is weak is extremely rare.
As mentioned in the last update, a lower USD also has big repercussions on the rest of the financial markets including precious and industrial metals.
Following our quantitative research, we’ve found Silver (SLV) and Copper miners (COPX) are the best bets to make on a weak USD from current levels. We’ve added both to our model portfolio.
The COPX/SP500 ratio (relative performance of Copper miners against the SP500) seems to have bee forming a large basing pattern since 2016. This often happens when valuations get very cheap (which is currently the case for COPX).
A weak dollar should boost Copper prices and the miners are likely to outperform the underlying metal (potentially leading to a breakout of the pattern) This gives an elevated potential reward on COPX from a technical standpoint.
Silver is a leveraged bet on the USD. In fact, the metal outperforms Gold significantly during periods of USD weakness (Gold/Silver ratio falls when USD weakens).
The Gold/Silver ratio is retesting the top of a multi-decade range. A weak USD is very likely to bring the ratio back into the range which could trigger a large and swift outperformance of Silver relative to Gold as the ratio comes back to test the bottom of the range.
Emerging markets also benefit greatly from a weaker USD, we will be posting a strategic piece taking a dive into the best Non-US stock market bets we can make in the current market environment.
Lightning SP500 Update:
Momentum is curling lower but remains objectively bullish.
The short-term daily price channel remains intact.
3900 point support level is a key level to watch. If price does not hold the level, all bullish structures are broken and the probability of downside increases.
The 10 year government bond yield is not rising with the most recent SP500 weakness. This suggests that the bond market is not anticipating that hawkish monetary policy is likely to be a headwind in the near term.
The chart below tracks the SP500 against the inverse of the 10 year yield to show the relationship more clearly.
Lower yields have meant higher stocks throughout 2022, we don’t believe this dynamic si changing yet because the bond market is pricing in lower inflationary data.
If this trend continues we should expect it to be a tailwind to stock market valuations. The Producer Price Index suggests inflation is indeed breaking down.
PPI, typically seen as a leading indicator of CPI suggests inflation is breaking down.
Credit risk is not rising, meaning no flashing warning signal for stocks right now. Quite the contrary.
Ideally we would like to see a breakdown in the credit risk uptrend, that would be a confirmation that stocks have lots of room to run in the near term.