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It is now six months since US and world markets hit a bottom after a sudden and extreme burst of volatility in early February. The rally that had preceded that sudden fall had been remarkably uniform. Fuelled by belief in a synchronised global recovery, it saw Europe and the emerging markets in the lead, ahead even of the booming US stock market. This is how the recovery after the dip has proceeded:
Since the nadir, the S&P 500 has gained 10.8 per cent — a very impressive clip. FTSE’s index for the rest of the world, excluding the US, is actually down, by 2.8 per cent, since then.
There tend to be big swings between the US stock market and the rest of the world over time, but the current six-month burst of US outperformance is the strongest in four years.
Not even the Federal Reserve has spoiled the party, even as it has raised rates twice and convinced the market that two more rate rises are in store this year. US 10-year bond yields have stayed largely under control over the past six months, but are higher than those for most of the rest of the developed markets.
So what is going on? One explanation is spelt Fang (or more often Faang these days). The US has a group of dominant internet companies, led by Apple and Amazon, that have been making hay, while nobody else outside of China has anything like them. In the past six months, the NYSE Fang+ index (which includes the Chinese companies Baidu and Alibaba as well as the hardcore US FAANGs) has rallied 21 per cent, while the MSCI EAFE information technology index, covering tech companies in the developed world outside the US, has risen only 2.3 per cent.
This is not a tech phenomenon so much as a Fang phenomenon. Investors are working on the assumption that a small group of the internet winners are well entrenched in their positions and will keep winning, rather than making a broader bet on technology, which tends these days to be a cyclical sector.
If America is living by the Fangs, that raises the risk that it may in due course die by the Fangs, should investors lose confidence in them or should increasing political disquiet at their power turn into concrete action to remove some of their competitive advantages. Another explanation revolves around data. At the end of last year, European growth was a pleasant surprise, while China was humming along and still finding a way to rein in credit. Now the US stands alone. Europe’s numbers are anaemic, while China is arousing concerns again.
And all of this plays into perhaps the greatest driver of US outperformance: the once-again strong dollar. The DXY dollar index — a popular trading unit that compares the US dollar to a basket of its major trading partners in the developed world — has just hit its highest level in 12 months. That has helped heap pressure on EMs. JPMorgan’s index of EM currencies has sagged 10 per cent in the past six months, bringing it close to an all-time low. This is how the dollar has performed against the developed and emerging currency blocs since election day in November 2016:
In the short run, this makes total sense. The rising currency automatically makes dollar-denominated securities stronger relative to others. In the case of the emerging markets, as I have covered earlier in the week, the causes go deeper. There is a traditional strong inverse relationship between the dollar and emerging market assets, driven largely by the effect a stronger dollar has on the ability to repay dollar-denominated debt.
But the relative impact compared to other stock markets is less clear. Japanese stocks benefit from a weaker yen. A stronger dollar weakens the competitive position, and the overseas profits when converted to dollars, or US multinationals.
When I tried mapping the DXY index against the relative performance of the S&P I found the following:
A strong dollar does indeed generally help the relative performance of US stocks. But the strength of the past six months looks hugely overdone. It looks as though mountains are rising beyond mountains. A strong dollar also undermines attempts to win a trade war; we might expect to see the US administration attempt to weaken it in the near future, and we might also expect the dollar's strength to begin to undermine the lonely domination of the US stock market.
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