“People who work crossword puzzles know that if they stop making progress, they should put the puzzle down for a while.” — Marilyn vos Savant, listed in the Guinness Book of World Records under “Highest IQ” from 1986 to 1989 and entered the Guinness Book of World Records Hall of Fame in 1988.
English engraver and cartographer John Spilsbury is said to have invented jigsaw puzzles during the second half of the eighteenth century. He was concerned, allegedly, with promoting a new way of teaching geography. We suspect, he is unlikely to have envisioned how his invention would evolve to become a form of entertainment for the masses.
Jigsaw puzzles as a form of entertainment for adults emerged around the start of the twentieth century and by 1908 a full-blown jigsaw craze had started in the United States which quickly spread across the Atlantic to Britain, and then around the world. The trend is said to have started in Newport, before spreading to New York, Boston and abroad. Adults across all rungs, except the very lowest, of society were sucked into the craze and puzzles became a primary form of entertainment in high society house parties in Newport and other country retreats. Although the fever eventually subsided, puzzles remained a regular source of adult amusement for the next two decades.
The onset of the Great Depression in 1929 coincided with a resurgence in the popularity of jigsaw puzzles. Sales are estimated to have peaked in early 1933 at a remarkable 10 million units per week. Puzzles, it seems, offered an escape from the financial woes of the times, as well as providing a sense of accomplishment during a time when jobs were hard to come by.
For us, price charts and evolving relationships between macroeconomic variables are the pieces of a puzzle we are continuously striving to put together in order to have a clearer picture of the market.
In this week’s piece we run through some charts and macroeconomic relationships that dominate our thinking at the moment.
US Credit Flows and the US Dollar
Prior to the Global Financial Crisis, the year-over-year change in the broad measure of US money supply, M2, was a very good proxy for trading the US dollar. Essentially, if the expectations were of credit to flow at a faster clip in the US economy, it paid to be long the dollar. If one the other hand, if the expectations were of credit conditions to tighten, it was better to be short the dollar.
The chart below plots an adjusted measure of year-of-year growth in broad US money supply, with the US dollar index, $DXY. The relationship worked swimmingly till the run up to the financial crisis. Following the crisis, there has been a disconnect that has largely remained.
What we think changed following the crisis is broad money supply no longer being a suitable proxy for the flow of credit in the US economy. And the source of that change was the Fed’s large scale asset purchases in response to the financial crisis. The purchases were funded through the increase in reserve balances in excess of regulatory reserve minimum requirements. Essentially, the growth in the broad money supply following the crisis was not translating into increases in the flow of credit because banks were parking money with the Fed.
The below chart further adjusts the money supply time series for increases and decreases in the supply of excess reserves — the year-over-year growth (decline) in excess reserves is deducted (added) from (to) M2 to obtain a better estimate of the flow of credit in the US economy.
We think this chart captures the recent resilience of the US dollar. Although credit in its traditional forms, as depicted in the first chart, has remained tight, the draw down of excess reserves due to quantitative tightening has supported broad money supply growth. This in turn has been, we think, supportive of the greenback.
Given this adjusted metric, we can now hypothesise on the ways forward for the dollar.
For now, given the Fed’s intention to stop shrinking its balance sheet from September onward, the dollar’s continued resilience will hinge upon other sources of growth in credit. The reemergence of President Trump’s infrastructure bill could be one such source — should it materialise, it is likely to draw capital to the US from the rest of the world and push the dollar to new highs. Till it transpires, however, the risk-to-reward ratio is not in favour of dollar bulls.
Large scale infrastructure spending in the US may also be the scenario under which commodities and the dollar strengthen in sync while US Treasuries do poorly.
Emerging Markets
Given the crackdown on shadow banking in China, the waxing and waning of Chinese shadow financing is no longer a primary driver of emerging markets.
Standalone and relative to the S&P 500, emerging markets do not look bearish at an aggregate level.
Russia is increasingly looking like the market to own in emerging markets. (The bottom panel is the MSCI Russia Index relative to the MSCI Emerging Markets Index.)
The gains in oil this year, however, have not fully been reflected in the Russian equity market’s performance. (The bottom panel is the MSCI Russia Index relative to WTI crude.)
While those long $ARGT should be looking to sell into Argentina’s inclusion into the MSCI Emerging Markets Index at the end of May.
London-based emerging markets asset manager, Ashmore Group $ASHM.LN, has had a great run even relative to the emerging markets index. It is up 30.3% year-to-date in US dollar terms.
Long Term Yields in China and the US
The below chart compares China’s purchasing managers’s index (advanced by three months) to the yield on 10 year Chinese government bonds.
Despite China’s inclusion into global bond benchmarks and record foreign inflows, yields are no longer moving lower suggesting that long-term yields in China may have bottomed — the recent pickup in PMI indicates as much as well. If yields have bottomed, or close to it, it is also likely that economic activity in China, too, is set to pick up.
Long-term yields in China have over the last decade largely mirrored movements of long term yields in the US. If Chinese yields have bottomed and economic activity is picking up, we would not be surprised to see US long-term yields move higher from here as well.
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed