In this weekend update, we look at the pullback in equities and the FXI in 2015 and the U.S. dollar inverse move.
We have discussed the connections between commodities and economic growth and discussed the fact we are continually becoming more and more a global economy rather than interconnected independent economies. When the U.S. does well, the world has a tendency to do well. When the U.S. and other economies are doing well, manufacturing economies, especially China, grow quickly. In the past few months, we noted the very bullish, even parabolic move of the iShares China Large Cap ETF (FXI) and the correlated move up in equities. Even more impressive is the correlated time and similar magnitudes of the moves in FXI and the S&P 500 back in 2015 and up to recent dates.
FXI dropped 47% in just under 9 months and shortly after, the S&P 500 dropped 16% from the high. Over the past two weeks equities have pulled back by 12% and investors seem scared. We seem to have forgotten the pullback in 2015 as a move that dropped into correction levels. If we would have been watching the pullback more closely, we would have seen the Russell 2000 drop over 28% during a similar timeframe.
If this correlation was not enough to consider, consider the correlated drop in copper during the same time frame and the rally of the U.S. dollar. In 2015, copper prices followed FXI and lost 42 % before finding a base. Copper gained following China and the U.S and rolled over the past couple of weeks keeping the correlation strong. The U.S. dollar gained 24% during the drop in FXI, SPY, and /HG. If we see a similar drop in equities and China, we could see another 5-8% drop in the S&P 500 and could theoretically see the U.S. dollar return to multiyear highs, possibly rising to 108.00 on the $DXY.
The concerning aspect of this correlations is that we saw a similar correlation In 2008. If the markets correct more than 20% we could see a very strong U.S. dollar but could see a very week equity market and potentially even a weak U.S. economy. It is a good time to look for opportunities but also a time to watch for warning signs.