We have now seen 24 different central banks across the world (with the Bank of Korea joining in late last week) lowing central cash rates to stimulate their respective domestic economies. And we are now face a situation where the Federal Reserve is looking at tightening. This has never happened before; the Fed has never found itself on the other side of global policy and this central bank divergence is making the USD the most sought-after currency on the planet.
This creates a very strong set of topics for discussion:
- USD strength – the concern about the strength of the USD has prompted a strategy change in the equities that investors are purchasing. The earnings decline from FX headwinds and the 50% decline in oil price will have a neutral effect on earnings as a whole for the S&P. However, those stocks with international exposure will underperform their domestic-facing counterparts. The drive to US stocks with high domestic revenues is ramping up and so far these stocks versus the broader market are outperforming year-to-date by over 6%.
- EUR/USD – collapsing by the day, the pair is down 12% since December 31 and 24% since December 31, 2013. The consensus expectations is that the pair will be a further 10% to 12% lower come December 31, 2015. This will mean parity will not only be breached, but a further 5 cents of value will be lost. We remain of the view that European equities will outperform most global equities as the ECB ramps up its QE program and the EUR promotes earnings tailwinds.
- Cash returns – firms across the global remain transfixed on returning capital to shareholders. The stats from the US are well known, with over $920 billion being returned to shareholders in share buy-backs and dividends in the past three years (22% of today’s S&P market cap). In Australia, the capital return levels are approximately the same. Payout ratios continue to rise and the forecasted payout ratio for the end of FY15 for FY15 is 60% to 70% compared to previous year averages of 40% to 45%; the yield trade will remain as popular as ever.
- VIX moves – the USD strength is creating volatility, the risk to earnings, and the risk of repatriation and capital outflows is driving the historically low VIX back towards elevated levels. If the divergence between EUR, JPY and GBP really ramp up over the next three months, which is a real possibility with the central bank divergences, the VIX will move higher and the S&P will continue to underperform the rest of the world.
Ahead of the Australian open
Iron ore resumed its declines on Friday, falling to US$57.66 a tonne overnight; BHP’s ADR looks to be leading the charge lower and will take the whole materials space with it. The decline in energy will just provide a further push on the market.
With the USD rally resuming on Friday, the US futures on Saturday took a severe hit falling 0.7% and the SPI was off 0.3%. Based on the close of the futures markets on Saturday, we are currently calling the ASX down 24 points to 5791 as the current market topics are debated.