The U.S. dollar will outperform every other major currency in the next three to five years, and equities are on the cusp of the next secular “bull run,” according to Scotiabank economist Nick Chamie.
Speaking at the Cayman Investment Forum hosted by the CFA Society on Oct. 30, Mr. Chamie presented four medium- to long-term themes that are going to shape investment performance.
His positive outlook for the U.S. dollar is based on strong economic growth rates in the U.S., which posted a 4 percent gross domestic product increase in the second quarter and 3.5 percent GDP growth in the third quarter.
U.S. growth is expected to outperform every other industrialized country’s next year, he noted, and interest rates are set to increase as well. “We project somewhere in the region of 100 to 150 bps of upward adjustment in bond yields depending on where we look at on the curve over the next two years.”
This will be in contrast to stable or declining interest rates in Europe and Japan and should represent a significant improvement in yield for the U.S. dollar.
More importantly, the de-leveraging cycle in the U.S. is extremely mature, Mr. Chamie said. “They have done a lot of work to reduce their debt.”
Debt loads in the U.K. and Europe, meanwhile, have grown without much improvement and in the developing world debt loads continue to rise.
In addition, valuations of the U.S. dollar against other trade currencies remain cheap on a historical basis, he said, meaning that “the conditions are set for a three to five year bull run of the U.S. dollar.”
Taking a long-term view of equity trend cycles, going as far back as the 1900s, Mr. Chamie painted a picture of consistent decades-long bull and bear cycles.
The last secular bull market during the 1980s and 1990s ended with the bursting of the dotcom bubble in early 2000. Since then, stock markets have experienced a secular bear market, he posited. With the stock markets more recently achieving new high highs, U.S. de-leveraging and better fundamentals that have improved the wellbeing of the global financial system, “we are about to embark on a new secular bull market,” he said.
Fixed income and commodities
Contrasting the positive outlook for the U.S. dollar and stocks, the Scotiabank economist urged caution with regard to fixed income and commodities, which he believes are set to underperform during the next three to five years.
“Investors should become much more cautious around fixed income, particularly high yield,” he said.
After five years of zero percent interest rates, Scotiabank believes the Federal Reserve will increase interest rates between now and the middle of next year. The resulting yield changes for bonds are much more price sensitive when interest rates are low and can be expected to impact the performance of bonds more strongly. At the same time, Mr. Chamie noted that the market for interest rate futures had vastly underpriced future interest rates compared to Federal Reserve forecasts.
“We think investors have to be cautious in terms of their overall allocations to fixed income, which have grown tremendously over recent years, and the need to position themselves properly within a global fixed income asset class.”
Specifically, the high yield segment gives cause for concern because it represents the most likely candidate for an asset bubble.
“After five years of zero percent interest rates and quantitative easing around the world, the money had to go somewhere. We believe it probably went into high yield,” he said.
High yield bonds meet all the conditions for a bubble, including the presence of easy money, overvaluation and tremendous growth of the size of the asset class.
Investors are holding about four times as many high-yield bonds than they did in December 2008. And like other bond yields, yields for high-yield bonds have dropped to all-time lows. “I am not sure that at 5.5 percent high yield investors are compensated adequately for the risks they are being asked to take,” Mr. Chamie said.
Commodities, such as copper, gold or oil, which had a very positive performance during the past decade, have entered the downside of the supercycle.
Demand is expected to decline as China’s economy, the single most important driver for commodities growth, is slowing. Improved supply, such as the growth of shale oil and newly discovered copper deposits, will depress commodities prices further.
This, in combination with the strong correlation between a positive performance of the U.S. dollar and declining dollar-priced commodities, means that the downward trend is likely to continue for another three to five years, Mr. Chamie stated.