Unloved rally finds romance

The equity market rally that has marched along unloved for the past 12 months now appears to have found romance, with investor appetite blooming. US stocks made new highs last week whilst inflows into global equities have increased rapidly.

There are several drivers including the weakness of the US Dollar, the effect of global growth on earnings and US company tax cuts. Interestingly, there is very little mention of valuations.

Greenback gains fleeting

US President Trump took time to talk up the US Dollar over the weekend, but the gains he prompted were short lived. The US Dollar now continues to weaken against the Euro, the Yen and the Aussie Dollar. The Australian Dollar has, however, weakened against the Euro and Yen suggesting that its rally is more about the weakness of the US Dollar rather than any improving fundamentals in the Australian economy.

One explanation for the US Dollar’s ongoing decline is the trend by currency reserve managers to diversify away from the US. Both the Bundesbank and the Bank of France, for example, are holding (or planning to hold) Renminbi as part of their official reserves. This is also in line with the recent sell-off in US Treasuries.

Commodities drive higher

The falling US Dollar, combined with hopes of a further boost to the global economy, has driven commodity prices higher. The Bloomberg Commodity Index has reached a two-year high, adding a further gain of 10% since mid-December.

Crude prices have hit three-year highs, with Brent Crude rising above $71 a barrel for the first time since late 2014. Its US counterpart, West Texas Intermediate, is now trading at $66.22 a barrel.

With regards to base metals, solid momentum in the global manufacturing sector has been a key driver of prices. The London Metal Exchange Index, which contains six industrial metals, has risen 2.5% to a five-year high. Nickel prices have climbed to their highest level since May 2015 at $13,715 a tonne, whilst copper inched up to $7,161 a tonne.

The broad-based buying has also helped agricultural commodities, which have been in the doldrums over the past few years as good crops and record level inventories have weighed on prices. Wheat has rallied 4% and corn 2%.

Fed rises fail to dampen equities

The US Federal Reserve’s gradual tightening of monetary policy – along with the prospect of more to come – has so far done very little to dampen investor enthusiasm for US equities. We’ve now had three quarters of growth above 2.5% in the US (the fourth quarter of 2017 came in at 2.6% annualised) yet investors continue to underestimate how much the Fed will raise interest rates in response to higher core inflation.

A faster-than-expected rise in short-term interest rates will be one of the reasons the US 10-year Treasury yield will resume its rise before long. This will probably push longer dated interest rates in Australia higher as well.




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