A strong US Dollar (USD) will lead equity markets higher in 2012. The US economy is looking the best amongst the worst and that includes India and China, leading to the US equity markets and the USD being the best performers since the beginning of August 2011. August 2011 was the month when debt problems in the Eurozone and inflation issues in India and China hit peaks leading to the beginning of a collapse of equity and currencies across the world.
US markets stand out in the return comparison above and the reason is that the US economy has progressed in the last eight months. The economy has added 1.2 million jobs in the last six months, the highest in a six month period since 2006 while its unemployment rate has fallen to 8.3% from levels of 9.5%. The US Federal Reserve (Fed) has maintained rates at zero percent levels but it has refrained from carrying out a third quantative easing program and has instead been replacing short dated government bonds with long dated government bonds (operation twist) to bring down long term yields in the economy.
The performance of currencies reveals the fact that the US economy looks better in comparison with other economies. The Euro has lost 8.5% against the USD over the last eight months as the sovereign debt issues facing the Eurozone has prompted the European Central Bank (ECB) to pump in huge amounts of liquidity into the system. The ECB has infused Euro 1 trillion of liquidity through LTRO (Long Term Refinancing Operations) in order to stabilize bond yields of indebted nations of Italy and Spain. The Eurozone is seeing mild recession on the back of austerity measures adopted by Eurozone nations to bring down debt, with fourth quarter GDP showing negative growth.
The Indian Rupee (INR) has lost 13% against the USD on the back of a widening current account deficit, which has gone up by 1% in fiscal year 2011-12 against 2010-11 and on the back of a slowing economy due to high inflation and high interest rates. India GDP growth fell to 6.1% in the third quarter of 2011-12 from 6.9% and 7.7% levels seen in the second and first quarter respectively. India faced inflation at over 9% levels for most of calendar year 2011 prompting RBI (Reserve Bank of India) to raise policy rates for whole of fiscal 2010-11. India has forecast growth at 7.6% for 2012-13, below trend levels of over 8% seen in most part of the 2000 decade.
The Japanese Yen, which benefitted from risk aversion trades in 2011 and trended down to decade highs of JPY 75 to the USD, has lost around 8.5% since August 2011. The fact that the Japanese economy is still recovering from the March 2011 earthquake has prompted the Bank of Japan to increase its bond purchases by USD 130 billion. Japanese interest rates are the lowest in the world with ten year bond yields at around 1% levels.
Chinese equities have borne the brunt of China’s property bubble and the government’s efforts to curb the bubble. China’s GDP growth forecast for 2012 is at 7.5%, the lowest since 1999 and the government is committed to reigning in property prices. Bank lending that has driven property prices to all time highs in China, has threatened the balance sheet of Chinese lenders as prices look to be dropping. China also faced its highest trade deficit since late 1980’s on the back of weak exports as economies in the Eurozone and Japan faced headwinds.
A rising USD will be positive for equity markets as it signals an improving US economy rather than risk aversion trades. However the equity rally will have a different face as commodity markets struggle in the face of strong USD and in the face of economies of China, India and the Eurozone growing at below trend levels. Investors should analyze what a strong USD means for different sectors and then look to invest in those sectors.