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The Roadmap To 2015 (Part 2)

The Link Between A Strong U.S. Dollar & Its Implications For Asian Stock Markets

Last month, I have discussed the various key levels and elements to watch for the U.S. S&P 500 Index in “The Roadmap to 2015 (Part 1)”. Click on this link for more details on my previous write-up.

On 29 October 2014, the U.S. Federal Reserve central bank has announced that it will cease its monthly purchase of U.S$15 billion worth of treasury bonds .This will put an end to its “aggressive” monetary expansionary programme known as “Quantitative Easing” (QE).

Interestingly, the other major developed countries’ central banks in the European Union, Japan and recently, China have embarked on a more aggressive stance in their monetary policies as they seek to “pump-up” their ailing economies through “QE” or other forms of monetary expansion policies.

This divergence of monetary policies between the U.S. and the rest of the developed countries will cause high volatility in the financial markets in 2015 and most importantly its implication on the direction of the U.S. dollar.

Let’s us take a look at the long-term chart of the U.S. Dollar Index futures to uncover its key levels and likely direction for 2015 from a technical analysis perspective

U.S. Dollar Index

 Key elements

  • The Index has found a major “bottom” through a bullish breakout of a 6-year old “Symmetrical Triangle” pattern (in dotted purple) in place since March 2008.
  •  Current price action is coming close to a significant graphical resistance at 91.10/92.30.
  • The Stochastic oscillator is at its “extreme” overbought level.
  • The 83.20 graphical support coincides with the pull-back support of the former “Symmetrical Triangle” pattern.
  • The next significant resistance is at 101.80/103.45 which confluences with the 61.8% Fibonacci retracement from 01 July 2001 high to 01 March 2008 low and multiple Fibonacci projections from various degrees.

The above mentioned elements are still advocating for a bullish U.S. dollar in 2015. But markets do not move in a vertical fashion, thus do expect a potential correction of 8% to 9% in the U.S. dollar Index in Q1 2015 as it is coming close to the first significant resistance zone of 91.10/92.30.  As long as the long-term key support at 83.20 holds, the U.S. dollar is likely to stage another round of upside movement to target 101.80/103.45 next.

The next question how does this expected U.S. dollar strength impact the Asian stock markets? The last time we see a significant U.S. dollar is during the period of April 1995 to July 2001 and the main catalyst is driven by effects of the Asian financial crisis that exploded in 1997.

The returns (excluding dividends) of the 11 Asian stock markets and the U.S. S&P 500 during the April 1995 to July 2001 period and its corresponding year-to-date returns (based on 03 December 2014 closing price) are shown in the table below

Shown for illustrative purposes only. Past performance is no guarantee of future results.

As seen from the above findings, the U.S. stock market as represented by the S&P 500 has enjoyed a remarkable return of 135.32% during the previous period of significant U.S. dollar strength seen in April 1995 to July 2001.  As for the Asian stock markets, the worst hits have been Thailand, Philippine and Malaysia due to their respective structural problems.

However, the fundamentals of these Asian economies have changed over time as indicated by their YTD (year-to-date) returns, thus it will be better to use a more objective approach to analyse their expected performance in 2015.

Since a strong U.S. dollar is likely to attract capital flows into dollar denominated assets, let’s us plot the respective Asian stock market index ETF (Exchange Traded Fund) against the U.S. S&P 500 ETF (as a ratio). This approach of technical analysis is called “Relative Strength” charting.

“Relative Strength” charting will enable us to have a gauge whether the various Asian stock market indices are outperforming, underperforming or neutral against the S&P 500.

The top three outperformers are as follow based on their respective “Relative Strength” charts;

Japan versus U.S.

The *Wisdom Tree Japan Hedged Equity Fund / S&P 500 ratio remains above its 20 and 50-week Moving Averages and still have has “room” towards its significant resistance zone. In addition, the MACD trend indicator has just turned bullish.

*The Wisdom Tree Japan Hedge Equity ETF tracks large caps Japanese equities and implements currency hedging against the movement of JPY.

China versus U.S.

The FTSE Xinhua A50 China Index / S&P 500 ratio has just broken out of its 5-year major downtrend resistance line and the MACD trend indicator has just turned bullish. All these elements are advocating an early stage of a potential bullish trend reversal in terms of outperformance against the S&P500.

India versus U.S.

The MSCI India Index/S&P 500 ratio remains in an uptrend since 26 August 2013 but upside momentum has started to wane as it has traded below the 20-week Moving Average.

In contrast the top underperformers are as follow;

Hong Kong versus U.S.

Malaysia versus U.S.

Singapore verus U.S.

Conclusion

The bullish trend of the U.S. dollar’s strength should continue into 2015 but do expect a potential correction of 8% to 9% below the first significant resistance zone of 91.10/92.30 in Q1 2015 before another leg of upside movement occurs.

The Asian stock markets that are likely to outperform in the strong U.S. dollar environment are China, Japan and India according to their respective “Relative Strength” charts plotted against the S&P 500.

Charts are from eSignal

Stay tune for next month “Roadmap to 2015 (Part 3)” where I will highlight the outlook of the major commodities.

Disclaimer

The information contained in this material is intended for general circulation only.  It should not be construed as a recommendation, or an offer (or solicitation of an offer) to buy or sell any financial products. The information provided does not take into account your specific investment objectives, financial situation or particular needs.  Before you act on any recommendation that may be contained in this report, independent advice ought to be sought from a financial adviser regarding the suitability of the investment product, taking into account your specific investment objectives, financial situation or particular needs.  All queries regarding the contents of this material are to be directed to City Index Asia Pte Ltd.

 

kelvin_wong
Kelvin Wong, CFTe

Chief Technical Strategist (Asia), City Index

Kelvin is professional technical analyst with extensive experience in stock indices, equities and foreign exchange. Kelvin employs a combination of fundamental and technical analysis and specialises in utilising Elliot Wave and Fibonacci analysis to pin point potential reversal levels in the financial market. Prior to joining City Index, Kelvin has traded actively and provided investment advisory for institutional traders/investors such as Deutsche Bank, Credit Suisse, ANZ and Goldman Sachs. He has also conducted technical analysis related trading workshops and seminars for thousands of private traders in Singapore and Malaysia.