Dogs of the World, Dollar & Currency Markets
July 24, 2018
Trade war drums are beating in 2018 as the Trump administration implemented and has threatened to implement nearly $1 trillion in tariffs on exports into the U.S. The drum beat got louder last week as the administration threatened $500 billion in tariffs on Chinese exports with China threatening to retaliate with more tariffs on the U.S. Traders expect a trade war to hurt the Chinese and the economies of emerging market nations more than the U.S. economy. The Atlanta Federal Reserve's GDP NOW estimate is at 4.5% annualized for the second quarter of 2018, which is fueling higher U.S. Treasury Bill yields. Highlights– Data ends July 20, 2018
The Arrow Insights (AI) Dogs of the World Index – ex USA (AIDOGS) selects the five worst performing countries among a universe of 44 developed, emerging and frontier countries at the end of each November with implementation on the last trade date of the year. AIDOGS allocates 30% to the worst country, and 17.5% in the remaining dogs. For the most part, since April 30, 2009, AIDOGS has gained as the MSCI Emerging Markets Stock Index has declined. Emerging market stocks decline more when the U.S.–dollar–(USD) to–emerging–market–currency ratio rises as investors sell the Chinese yuan and emerging country currencies and buy the USD, especially since the end of 2016 (yellow vertical line, Figure 1). The narrowing of the yield spread between U.S. yields and Chinese/emerging market yields supports the current trend in currencies.
- Since April 30, 2009, AIDOGS and the MSCI Emerging Markets Stock Index have recorded total returns of 238.1% and 61.5%, respectively (Figure 1).
Figure 1. AIDOGS Bests Emerging Markets Stocks
Chart courtesy of StockCharts.com. Performance prior to December 14, 2017 was based upon back testing the AIDOGS methodology (Source: Thomson Reuters).
AIDOGS expresses a rationale that the worst performing stocks within the worst performing country markets will revert to their historic mean return (mean reversion). Historically, AIDOGS has been more volatile than SPXTR, but less volatile than the MSCI Emerging Markets Stock Index (not shown in Figure 1). These factors should cause index investors to favor allocating part of their global allocation to AIDOGS with the allocation sourced from their customary allocations to the foreign stocks.
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