Hedging Fund Analyst: The Weakening Dollar Ignites an Investment Boom in International Markets, Fund Rotation is Just Beginning

The US dollar has depreciated to its lowest point in over two years, with funds rapidly flowing into emerging markets. The iShares MSCI Emerging Markets ETF (EEM), which holds 800 emerging market stocks, has risen for nine consecutive trading days, marking the longest rally for the fund since its inception in 2016. The index has also returned to levels seen before the outbreak of the Ukraine-Russia war, indicating that a new wave of capital rotation has just begun in the market.

The depreciation of the US dollar drives the revaluation of risk assets.

Crescat Capital macro strategist Otavio Costa stated in an interview with Benzinga that if the US dollar continues to depreciate, investors will actively seek allocation in natural resources and hard assets, as well as emerging markets with relatively low valuations. If everyone believes the dollar will depreciate, they will want to allocate to assets with intrinsic value, and emerging markets present such investment opportunities.

Costa believes that the current debt burden of the United States has transformed into a structural problem for the dollar. He pointed out that interest expenditures of the federal and local governments in the U.S. account for about 5% of GDP, far higher than the approximately 1% level of developed countries like Germany, Japan, and Canada. This indicates that the fiscal flexibility of the U.S. is relatively weak, and it may face pressure to cut interest rates faster than other countries in the future. Once the interest rate spread narrows, the dollar may further weaken.

The Brazilian market is a potential emerging market.

In terms of valuation, Costa stated that the Cyclically Adjusted Price-To-Earnings (CAPE) of US stocks has reached 35, close to historical extremes; in contrast, the CAPE of emerging markets such as Brazil is only about 12. He questioned why capital is not allocated to those undervalued markets. He is particularly optimistic about Brazil, not only because its stock market valuation is attractive, but also because the local bond market has good return potential.

Canada may become a safe haven after the US dollar weakens.

Among developed countries, Canada is an undervalued potential market. Costa pointed out that Canada is a noteworthy reverse investment target. Although not an emerging market, Canada has a high correlation with natural gas and commodities, presenting market opportunities. Costa believes that the Canadian dollar has been underweighted in the market for a long time, and with the high correlation of oil and natural gas prices, it may welcome a rebound opportunity during a period of US dollar weakness and commodity upcycle.

In terms of fixed income, Canadian bonds are also attractive to conservative funds due to their robust yield structure and better inflation control. As the market reassesses risk and reward, Canada may play a safe-haven role among developed countries.

Global market rotation emerges, attracting capital attention from multiple countries.

In addition to Brazil and Canada, Costa also mentioned that the markets in Argentina and India have recently performed well, especially with a noticeable capital inflow in Argentina after political reforms. In Asia, the Japanese and European stock markets have recently outperformed the US, further indicating that investment funds are flowing from the overvalued US stock market to other undervalued regions.

The US dollar breaks below the psychological barrier, and the market's bearish sentiment is rising.

The US dollar index recently dropped to 98.2 points, the lowest level since April 2022. The market generally believes that President Trump’s remarks regarding the dismissal of Federal Reserve Chairman Powell have strengthened concerns about political interference in monetary policy in the US. Several investment banks, including Goldman Sachs, have also turned bearish on the dollar, warning that confidence in the dollar may be damaged, further triggering inflation risks.

According to data from the Commodity Futures Trading Commission (CFTC), institutional investors' net short positions in dollars have risen to a new high since 2013, indicating a more pessimistic outlook for the dollar's future trajectory.

Emerging markets and resource-based economies become safe havens for capital

As the US dollar weakens, emerging market indices have rebounded to levels seen in February 2022. Costa emphasized that the current proportion of US interest expenditure to GDP continues to rise, which will increase the pressure for interest rate cuts and further drive capital inflows into emerging markets and resource-based economies, such as Brazil and Canada, in search of higher returns and risk hedging.

The continued weakness of the US dollar and the trend of global capital rotation may reshape the investment landscape. Investors should closely monitor the development of this trend and adjust their asset allocation accordingly to respond to potential market volatility. This article is purely a market observation and not investment advice.

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