Gold to the USA, Dollars to Europe

There has been much talk about the gold moving to the USA, but what about the dollars coming the other way? The dollar is down this year, with most of the gains shifting to the most undervalued currencies, notably the Japanese yen and the Swedish krona. This year has seen US stockmarkets stall, alongside Turkey, India, and the Asian Tigers, while Europe, Mexico, Brazil, and Hong Kong have flourished.

I have been talking about the great rotation away from US stocks towards the rest of the world, and that shift is now well underway. The largest US companies, which have done well, have wobbled over the past week, but the real sign of weakness comes from the mid and small caps. I show that over the past year, but note how they were in line with the large caps as in late November. It’s a big move.

US Mega, Mid and Small Cap Indices

The story is better told through momentum than market cap, which captures the current disparity more accurately. The blue past winners, the stocks that were already doing well, surged higher in November on the Trump trade and are now giving background. The red losers are stable, which indicates we are looking at a market rotation of leadership as opposed to a bear market at this point in time. The lower black line shows winners less losers and appears to have broken. That is unsurprising, given it packed at 40% over the past year.

US Momentum Winners vs Losers – Past Year

That black line over 25 years has risen with a trend rate of 4.3% p.a. It is currently at the top of the range and signalling a reversal. Cutting through the upper green line means the momentum trade is two standard deviations (that’s a lot) above the trend. It is impossible to say whether the correction will be mild or severe, but it is very likely underway.

US Momentum Winners Relative to Losers – Past 25 Years

The momentum trend is back to levels last seen in 2000 and 2008. Looking at the stock level, 6 of the largest 7 stocks are down this year, with only META still up. The earnings season is underway, and expectations for next year are clearly too high. That becomes clearer when we compare the global markets. The US is easing back, while Europe and the emerging markets are catching up. Japan is lagging as the yen finally begins its long-overdue appreciation. A strong currency is normally positive for a stockmarket, but not when the make-up is heavily export-driven, as is the case in Japan.

Key Global Markets – Past Year

Just as US momentum has cooled, European momentum has taken off. The best bit for me is that the losers are rising as well. This means a stockmarket downturn in Europe is unlikely at this point. The excess return has also been calm so far, with the winners just 10% ahead this year. This is far from being overcooked.

European Momentum Winners vs Losers – Past Year

Longer-term, the European momentum effect is above the mean (red line) but much less so than in the US market, being just one standard deviation above the trend (less than a lot). That means it’s less risky and has more to give.

European Momentum Winners Relative to Losers – Past 20 Years

The investment implications are to be aware that major change is upon us, and to be prepared to adapt. Unsurprisingly, Bitcoin has sided with US tech, but gold has remained firm; at least so far.