Mar 26, 2015 0
Over the past several months it has become increasingly clear that the US dollar has been the best house in an otherwise bad neighborhood. At Phoenix Capital we have been both a vocal proponent and a benefactor of this notion. There are several factors that support our stance on USD.
First, is the status of the US dollar as the world’s reserve currency. This has held true through the best of times, and the worst of times. Looking back at the 2008 recession, not only did the US dollar remain strong, it reached record highs through the tough times. Fast-forward to 2014 and the dollar rose significantly against all major currencies including the Euro, the British pound, and the Yen. In 2014 the dollar even surpassed levels we saw in 2008 and has remained strong early in 2015. While all of this has been happening, Phoenix Capital has been holding USD as a significant portion of our hedge fund portfolio.
There has been a distinct timeline of events that reinforced our initial justification for the position and allowed us to even amplify it. We began buying PowerShares DB US Dollar Index Bullish (UUP) towards the end of August 2014. Not long after that, the Euro began a decline coupled with rising U.S. bond yields. We continued to buy aggressively through September, and low and behold, the dollar continued to strengthen against other global currencies.
By November, US QE began to wind down and crude oil was well into a slump that it remains in today. All the while, the dollar increased in value, soaring to new peaks as crude oil and industrial metals both plummeted. Our last purchase of UUP was in December, and from there we have sat back and enjoyed the ride.
Our trading decisions in the case of UUP were not solely motivated by macro factors but were also based on support from some key historical data and statistics. At Phoenix Capital, we use a statistical methodology laid out in “The Big Trade: Simple Strategies for Maximum Market Returns” to support our market timing hypothesis. This strategy dictates that after choosing a fundamentally sound security or ETF, we use its past movement in different time frames to enter the market with confidence supported by clearly defined probabilities.
Our first purchase of UUP was made on Aug 28th, 2014. Based on weekly statistics with observations of high price, low price, opening price and closing price, we were able to craft some useful statistics. We noticed the price of UUP had been oscillating around 21.70 for the two weeks prior to entry, but this was followed by a distinct change when the week of the 18th closed at $21.94, indicating an upward trend.
One upward bar is not enough, however, and we needed more confirmation of a sustainable upward trend. The following Monday, August 25th closed at $22.00, thus exceeding the previous week’s high. From our historical data of a 476-day period for UUP, Mondays very often set a low for the week. Based probabilities derived from this data we could positively conclude that this week as a whole would likely mark a second-consecutive week of upward movement for UUP.
Upon choosing the week of the 25th as an opportune time to enter the market, we then moved forward with the next steps in “The Big Trade” methodology. The 25th opened at $22.00 and we waited for an incremental move to define the entry, but $22.00 remained the price at close. In cases where Monday is the week’s low, we have found a high probability that the week’s high will then fall on either Thursday or Friday. Based on this, we entered at the average price of $21.985 on Wednesday of that week. At this time, we were prepared to take a 10% stop-loss if the trend were to reverse. However, from the initial entry the stock has continued increasing and we have continued to build up our position to where it currently sits.
Moving forward, we anticipate this position to remain strong in the near future. The Federal Reserve recently announced their intentions to refrain from raising interest rates until “further improvement” is seen in the US economy. Many are interpreting this as saying we will have several more months of low rates.
But just how much longer can we expect the USD bull market to continue? There are certainly signs indicating that the bull run is nearing its tail end. First, the current USD rally has well exceeded its historical averages. Dating back to the 1970’s, USD rallies average 20% and last under one year. The current bull run has seen the USD rise 25% since June 2014. If we consider the low in April 2011 as the starting point this rise becomes roughly 40%.
In addition, one could argue that the dramatic downtrends we have seen recently in EUR and JPY as a result of aggressive QE policies are coming to an end. Historically, the anticipation period leading up to QE implementation, and the period when that QE is initially implemented are the times marked by the most significant downtrends. A period in which the currencies level out typically then follows these downtrends. If the EUR and JPY do level out, this will mean less significant gains for UUP, especially considering the significant weight carried by JPY and EUR within UUP.
Despite all of this, it is our conclusion that the USD will remain strong at least in the short term. With that said, there is plenty of evidence to indicate that the party is nearly over. It is not too late to get in on the trend with a purchase of UUP, however one must monitor the situation closely in the coming months, and by as early as the beginning of 2016 we could all be singing a different tune.