We all love ggplot. If you're an R enthusiast, you're probably no stranger to the magic of the ggplot2 package. It's a go-to tool for crafting beautiful, data-rich visualizations that turn raw numbers into insightful graphics. And rightfully so – ggplot2 is a fantastic resource that has revolutionized data visualization in the R ecosystem.

However, in our love affair with ggplot2, we might sometimes overlook a simpler, more straightforward approach: creating ASCII plots directly in a data.table. Yes, you read that right – good old text-based, no-frills plots that can be remarkably effective in certain situations.

In this post, we're going to take a step back from the world of intricate ggplot2 visualizations and dive into the charming simplicity of ASCII plots. Why? Because sometimes, having a plot generated directly in a data.table is the way to go: you can display it in the console, or automatically create HTML tables with plots for short reports, for example.

The plotting function

For the function that generates the ASCII plot, we'll use simple ASCII bars that range from ▁ to ▇. Unfortunately, this also means that our ASCII plot will be limited to those 7 bars with differing heights to display all of the data we want to plot. That's a limitation we have to live with - but since an table-embedded ASCII plot is best suited to plot "the trend" of the data, it's okay. For a full-fledged plot, just use ggplot2.

make_plot <- function(v) {
  
  sym <- c(
    "1" = "▁",
    "2" = "▂",
    "3" = "▃",
    "4" = "▄",
    "5" = "▅",
    "6" = "▆",
    "7" = "▇")

  rank <- dplyr::dense_rank(v)
  
  norm_factor <- max(rank) / 7
  rank <- rank / norm_factor
  rank <- ceiling(rank)
  
  plot <- ""
  for (i in rank) {
    plot <- paste0(plot, sym[[as.character(i)]])
  }
  return(plot)
}

The ASCII bars are put in a named vector with labels ranging from 1 to 7.

The core of the function relies on dplyr's dense_rank function. This nifty tool ranks the values in a vector according to their relative standing.

To illustrate, if you were ranking 10 random numbers between 1 and 50, they would be assigned ranks from 1 to 10 based on their respective values.

> test <- sample(1:50, 10, replace = FALSE)
> test
 [1]  5 24 49 47 33 48  4 18 19 27
> dplyr::dense_rank(test)
 [1]  2  5 10  8  7  9  1  3  4  6

Now that we've ranked our values, the next critical step is normalizing these ranks so that they all fall within our desired range of 1 to 7. As we're working with only seven ASCII bars, it's essential to ensure our data aligns with these available bar heights.

Lastly, we'll match the appropriate ASCII bar to our normalized rank vector, accomplished through a for loop towards the end of the function.

Let's see how our ASCII plot looks using a test variable.

> test
 [1]  5 24 49 47 33 48  4 18 19 27
> make_plot(test)
[1] "▂▄▇▆▅▇▁▃▃▅"

Not bad! The plot reaches its peak at the third position (with a value of 49) and hits its lowest point at the seventh position (with a value of 4).

Now, it's time to apply the magic to our beloved mtcars dataset. How about plotting the displacement of cars by cylinder?

First, we have to create a new column with a vector of displ values grouped by cylinder, and then apply the make_plot function to each row of the newly-created column.

dt <- data.table::as.data.table(mtcars)
dt[, col := toString(disp), cyl]  
dt[, col := strsplit(col, ", ")]  
dt[, plot := lapply(col, make_plot)]
dt[, col := NULL]

Voilà! Our data.table now boasts a simple yet effective ASCII-based plot showcasing displacement values by cylinder count.

Until the next post, may your data visualizations be as enlightening as they are engaging!

During the recent US election, the concept of the balance of trade was bounced around a lot, but not always used in the correct manner. This is due to a combination of politics and ignorance, and can be cured by understanding exactly how the balance of trade works.

What is the Balance of Trade?

The balance of trade (BOT) is an economic indicator that measures a country’s net exports, i.e. the difference between a country’s imports and exports for a specific period of time. The balance of trade usually has the largest share of a country’s balance of payments (BoP).

Countries have the incentive to achieve a positive balance of trade, which means they export more than they import. The opposite situation, where a country exports less than it imports, has a negative trade balance as result. A positive trade balance is also called a trade surplus, while a negative trade balance is called a trade deficit.

A country’s balance of trade doesn’t consist only of exports and imports of goods. Other components also include foreign aid, and domestic spending and investments abroad, which lower the value of the balance of trade. Foreign spending and foreign investments in the domestic economy are components, which beside exports, increase the value of the trade balance numbers. By subtracting the components that increase the balance of trade from components that decrease it, analysts arrive at the true trade surplus or trade deficit for a country.

How is the US Balance of Trade report published?

The US balance of trade is released monthly by the Bureau of Economic Analysis, around 5 weeks after the reporting month ends. In their publication titled “U.S. International Trade in Goods and Services”, the BEA gives detailed reports about the monthly imports and exports of goods and services, the trade deficits or surpluses both in absolute and relative figures, as well as the balance of trade per category of goods and services. Other popular reports include the quarterly released “U.S. International Transactions” and “U.S. International Investment Position”. The US trade balance economic release, as well as other reports of the Bureau of Economic Analysis can be found here:

https://www.bea.gov/newsreleases/news_release_sort_international.htm

Understanding the Fundamentals behind the Balance of Trade

A popular currency valuation model based on the Balance of Payments, of which the balance of trade is a part of, is the balance of payments approach. This traditional currency valuation model suggests that changes in national income affect both the current and the capital account, and causes a predictable reaction of the exchange rate in order to restore the balance of payments equilibrium. In this part of the article, we will examine the transmission mechanism from the change in national income through to the currency reaction.

First, let’s introduce the well-known identity for economic adjustment:

S – I = Y – E = X – M

Where:

S = Savings

I = Investment

Y = Income

E = Expenditure

X = Exports

M = Imports

Under a floating exchange rate regime like the US dollar, traders should be aware of both the capital account and current account (which includes the balance of trade). In this case, as national income rises, so import demand rises, causing the current account (balance of trade) to deteriorate. Now, the exchange rate acts as a transmission mechanism to restore the balance of payments imbalance. A rise in national income, which caused the current account deterioration, must be followed by a rise in real interest rates which will dampen import demand, causing the current account deterioration to reverse.

The Current Account Balance and the Exchange Rate

The current account balance can be used to forecast the long-term equilibrium exchange rate. Under this model, the equilibrium exchange rate is that which creates a current account balance in the long run, consisting of the balance of trade.

The trade balance of a country can affect exchange rates in several ways.

First, an external or trade imbalance can influence the flow supply and demand of currencies, and this way directly influence the exchange rates.

If the current account (balance of trade) is showing a high trade deficit relative to historic levels, the real exchange rate has to depreciate to restore the current account equilibrium. Similarly, if the current account shows a high surplus, the real exchange rate has to appreciate to restore equilibrium.

A good example regarding the current account surplus and the exchange rate reaction, is that of Japan and its large trade surplus with the United States. The country has generated an extremely high trade surplus with the United States from the seventies to the nineties, which required a substantial real exchange rate appreciation of the yen to restore the current account balance. Indeed, the dollar/yen exchange rate hit a record level of 79.85 by the end of the mentioned period. The following chart shows the relationship between the Japanese balance of trade and the yen during that period.

Second, an external imbalance can shift financial wealth from deficit countries to surplus countries, which can lead to a shift in global asset preferences. This in turn can affect the equilibrium exchange rates of currencies involved. Large external imbalances can alter the market’s perception of what exchange rate constitutes a currency’s real long-term equilibrium level. A steady rise of a country’s trade deficit and external debt levels will cause downward revisions in the perception of the long-term equilibrium exchange rate for a currency.

“Terms of Trade” and why it matters

When tracking a country’s current account balance for the sake of exchange rate forecasting, traders should also be aware of the “terms of trade” of a particular economy. The “terms of trade” of a country is simply the relationship between its export and import prices, and can give a valuable insight into the future real exchange rate. If a country’s terms of trade improve, that its export prices rise relative to its import prices, this can lead to a positive trade surplus which in turn causes the real exchange rate to appreciate to restore equilibrium. Similarly, a deterioration of a country’s terms of trade leads to a current account deterioration, which in turn requires a real exchange rate depreciation to restore equilibrium.

This is especially true for major commodity exporters and importers. For example, a rise of the price of oil will have a significant impact on the currencies of major oil exporters, and importers alike. Major oil exporters, like the countries of the Gulf, USA, Russia, UK and Norway will experience an improvement in their terms of trade with oil prices rising, which leads to an improvement in their current account and trade balance figures as well. This will create upward pressure on their equilibrium exchange rates. The opposite is true for major oil importers, they will experience a deterioration in both their terms of trade and current account/balance of trade. These circumstances will of necessity lead to a depreciation of their currencies in order to restore the balance of payments.

The Specifics  of the US Dollar and the Balance of Trade

The degree to which the US dollar will adjust to current account imbalances largely depends on the elasticities of the supply and demand curves, as well as the nature of which the current account imbalance arises. Let’s explain both concepts in the following part of the article.

The following chart shows two pairs of supply and demand curves for the US dollar, D^e_$and S^e_$ represent highly elastic curves, while D^I_$and S^I_$ represent highly inelastic curves. Let’s assume that q₁ is the present US dollar exchange rate. The distance between points A and B is the assumed US trade deficit. In order to restore equilibrium, the US dollar needs to depreciate to points where the supply and demand curves intersect, i.e. C or C’ in case of the highly inelastic supply and demand curves.

The elasticities of US exports and imports are estimated to be quite small, equaling to around -1.0 for exports and -0.3 for imports. Based on these low elasticities, the exchange rate adjustment of the US dollar needed to restore a current account balance would be rather large. Therefore, the inelastic supply and demand curves on the chart represent fairly the large degree to which the US dollar needs to depreciate to restore current account balance, with the new exchange rate at the point q².

The nature of the current account deterioration also affects the path which the exchange rate will take. In fact, a current account deficit can also lead to an exchange rate appreciation. Evidence of this can again be found in the US dollar, which appreciated dramatically over the 1995-2001 period despite a record high current account deficit.

A current account imbalance can occur not only by changes in value of exports and imports, but also by shifts in national savings and investments, as the identity for economic adjustment in the first part of this article shows. Indeed, the balance of trade can deteriorate and still cause an appreciation of the exchange rate. That’s why traders need to be aware of the bigger fundamental picture of a specific currency when trading the balance of trade report. In the long-term, fundamentals are the main driver of any currency. Technical analysis should be used to confirm the research of the fundamentals.

If a country underwent a major investment boom or undertook a long-term policy of fiscal expansion, both of these actions will cause an exchange rate appreciation despite a widening current account deficit. An increase in investments over national savings results in a widening current account deficit, and simultaneously creates upward pressure for the domestic currency. This is what happened to the US dollar over the 1995-2001 period, when US domestic investments exceeded savings to a large degree.

Specific changes in the economic adjustment identity can cause the exchange rate and the current account imbalance to move in the same direction, like the balance of trade deterioration leads to a weakening currency for example. Other disturbances can cause the exchange rate to move in the opposite direction than the balance of trade would suggest. The relationship among various economic conditions and their linkage to the current account and exchange rate are tabulated in the following table.

A popular method used to boost exports and lower the trade deficit is to intentionally devalue a currency, for example through monetary easing. In case of the USD, this would likely create significant problems. As the recent labour data showed, there is a possibility that the United States are approaching a full employment level. Weakening the currency to boost exports under such circumstances, would shift the US output past its full employment potential and create inflationary pressure. This in turn would require the Fed to tighten monetary policy, causing the US dollar to appreciate again.

How is the US Balance of Trade Performing?

As we have already mentioned, the balance of trade measuresthe difference between all exports and imports of a country. This comes with a lot of political strife as it is shown as an indicator that either violates or agrees with certain ideologies. Many will defend the idea of a free market regardless of the balance of trade, but others will argue for subsidies, tariffs, or quotas in order to lessen the balance of trade deficit.

The US trade balance in 2016 achieved a deficit $481 billion. Imports in the US totaled $2.7 trillion, whereas exports only totaled $2.2 trillion. This is an increase in the total trade deficit of around $18 billion compared to the $463 billion trade deficit of 2015, and represents around 2.6% of the US GDP.

The trade gap lowered to around $45.3 billion in March, but has since started to climb back up.

As we have hit the summer, imports have reached a recent high and the deficit has sustained. Just in April alone, the gap between imports and exports widened to $47.6 billion per month from the previous month’s deficit of $45.3 billion per month. This was considered to be the result of lower sales of consumer goods, specifically vehicles, the June trade balance news release showed.

In the recent period, as the US trade balance reportshows a widening deficit, the US dollar usually weakens. This inverse relationship can be noticed in the 2008-2016 period, and is shown on the following chart.

Two things that should be kept top of mind with the BoT is whether it includes goods and services, as well as what the deficit or surplus is relative to the country’s GDP. Additionally, the proportion of the deficit matters and is often quoted out of context. There is a huge difference between the USA having a $500 billion deficit and other countries with relatively high deficits but comparably low GDPs, which is why GDP should always be factored in.

Conclusion

When discussing the balance of trade, there is probably no right or wrong answer. It isn’t necessarily better to have a trade surplus than a trade deficit. When a company is exporting more than it imports, that means that there is high demand for their goods and services, but at the same time it is probably due to their currency being cheap relative to other currencies. A good example is China and its record-high trade surplus with the United States, which partly arises from the Chinese renminbi being intentionally undervalued by the Chinese government to boost export competitiveness.

Alternatively, having a trade deficit could just mean that a country’s currency has appreciated to the point where it is economically viable to import more due to the relative cheapness of goods and services from other countries.

The US president Donald Trump recently argued for more protectionist policies that will prevent continued importing of foreign goods, which opposes the benefits of globalization and free trade. The inability to import cheap goods means that domestic consumers are paying more for them. At the same time, foreign producers are unable to sell their goods due to these protectionist policies.

For these reasons, traders should always broaden their analysis to include other economic indicators, to get a reliable measure of how a country is doing. Learning the fundamental aspects of the market can help increasing your trading balance in forex, by placing high-probability trades based on sound and reliable analysis.

Nevertheless, even when investing in ETFs, investors need to perform their due diligence and form an optimal ETF portfolio based on their risk investment goals, risk tolerance, investment horizon, and lifecycle.

Not all investors have the same goals in the markets, so there is no one-size-fits-all in ETF investing. Here, we’ll shed some light on the best asset allocation ETF strategies when it comes to investing in ETFs.

Asset Allocation Strategies Explained

Whether you are investing in stocks, bonds, commodities, or ETFs, asset allocation strategies can help you reduce your overall market risk by diversifying and selecting an optimal asset allocation for your portfolio. Asset allocation ETF strategies are designed to meet the specific goals of an investor, whether it is capital preservation, capital growth, or regular income.

The following chart shows the correlation of different asset classes over time and the importance of diversification when investing in ETFs.

ETFs, or Exchange Traded Funds, are exchange-traded financial products that can be bought and sold on a regular stock exchange, and that invest in a group of financial instruments based on the underlying index that they track. You can find ETFs that track almost anything, from value stocks to precious metals, and from emerging market bonds to exotic currencies.

Understanding where you want to invest and what risk you want to take is the first step in creating a well-rounded ETF portfolio. Asset allocation strategies allow you to pick the right asset classes to meet your investment goals.

Questions to Ask Yourself Before Investing

Before we dig deeper into the main types of ETF asset allocation strategies, we first need to answer some important questions. Those questions will help you understand your ultimate investment goals, which in turn narrows your investment decisions and makes it easier to form an optimal portfolio mix.

· Investment Goals – What are your investment goals? Are you looking for maximum growth of your capital, regular income, or capital preservation?

Balancing these three goals is extremely important when investing in ETFs since you’ll have a hard time getting the best of all three worlds. Your investment goals are usually determined by your risk tolerance, investment horizon, and lifecycle.

· Risk Tolerance – Every investor has a different tolerance of risk. Some are risk-takers and put more emphasis on ETFs that track stocks, while others are extremely risk-averse and invest more of their funds into ETFs that track bonds and less-volatile asset classes. An important takeaway here is that, in general, higher profits come hand in hand with higher risks, while low-risk investments generally produce a lower rate of return.

· Investment Horizon – Another important point is your expected investment horizon. Do you want to stick to your investment for many years, even decades, or do you need your money back in a few months?

Investors who have a longer investment horizon are generally better off investing in more volatile asset classes like stocks, as they have more time to weather any market turbulence or bear markets. Investors with shorter time horizons should consider ETFs that track corporate or government bonds, and even hold part of their portfolio in cash.

· Lifecycle– Last but not least, younger investors usually have fewer financial resources but a larger capacity to work and more time to recover from economic recessions compared to older investors. As a result, younger investors are generally more risk-tolerant and allocate most of their funds in riskier ETFs, while older investors prefer low-risk income-generating portfolios.

As a rule of thumb: percentage of risky asset classes in an ETF portfolio = 100 minus the investor’s age. So if you’re 30, you could invest around 70% of your funds in ETFs that track stock indices, for example. A 70-year-old investor, on the other hand, should allocate only a small percentage of his wealth to risky assets.

Main Types of ETF Asset Allocation Strategies

ETF asset allocation strategies are often grouped by their risk and investment goals. Depending on your risk tolerance, you can choose from conservative allocation strategies to strategies that aim for maximum growth. Here’s how to invest with each of them.

· Conservative ETF Asset Allocation Strategies

Risk-averse investors are best off using conservative ETF asset allocation strategies. These strategies usually have lower expected returns but are also less risky than strategies that focus on capital growth. Conservative asset allocation strategies put emphasis on bonds and other fixed-income securities, while equities are underweighted.

A typical conservative portfolio would put around 20-40% in equities, and around 60-80% in fixed income ETFs. Real estate is another asset class that is underweighted in conservative strategies given the volatility in housing prices.

On the equities side, conservative allocation strategies prefer the more stable large-cap stocks. A popular ETF for large-cap stocks is the SPDR Portfolio Large Cap ETF. Those stocks can account for up to 30% of a conservative portfolio, while the remaining equities exposure is achieved by investing in small-caps and developed world stocks. Popular ETFs include the SPDR Portfolio Small Cap ETF, and the SPDR Portfolio Developed World ex-US ETF.

The core of a conservative ETF portfolio consists of fixed income, which accounts for up to 80% of the portfolio. The SPDR Portfolio Aggregate Bond ETF is a popular choice. Investors who want protection against inflation can also invest in Treasury inflation-protected securities through the SPDR Portfolio TIPS ETF.

Emerging markets bond exposure can be achieved by investing in the Bloomberg Barclays Emerging Market Local Bond ETF, but try to keep the largest part of your fixed-income investments in ETFs that track developed markets. A Vanguard asset allocation ETF is also a popular choice among active investors. Just like with SPDR or iShares, a Vanguard asset mix portfolio can be created to meet your investment goals.

· Moderate ETF Asset Allocation Strategies

A widespread asset allocation strategy is the moderate approach, also known as the “60/40”. This strategy invests around 60% in stock ETFs and around 40% in fixed income ETFs. Moderate ETF asset allocation strategies are a balance between riskier growth strategies and conservative capital preservation strategies, which makes them a popular choice among investors of any age and risk tolerance.

The largest stock exposure in moderate asset allocation strategies consists again of large-cap stocks, followed by stocks from the developed world. However, in this strategy, investors may also allocate a small portion of their capital into emerging markets, international small-cap, and emerging markets small-cap.

Popular ETFs for those instruments include the SPDR Emerging Markets ETF, the S&P International Small Cap ETF, and the S&P Emerging Markets Small Cap ETF.

Even though fixed income is underweighted in moderate allocation strategies, they still play an important part of the portfolio with around 40% of asset allocation. The SPDR Portfolio Aggregate Bond ETF and the SPDR Portfolio TIPS ETF remain popular choices in moderate allocation strategies, followed by the SPDR Bloomberg Barclays Short Term High Yield Bond ETF.

· Growth ETF Asset Allocation Strategies

While conservative and moderate asset allocation strategies are the preferred type of portfolios for risk-averse and risk-neutral investors, risk-seeking investors will likely feel that those portfolios don’t generate enough return. That’s where asset allocation strategies that are focused on growth come into play.

In a growth ETF asset allocation strategy, investors can put anything between 70% and up to 100% of their funds into ETFs that track the stock market. The remaining part of their funds should be invested into fixed income and global real estate.

Besides the already mentioned large-cap and small-cap ETFs, risk-tolerant investors may also invest a smaller portion of their funds into emerging market ETFs, international small-cap ETFs, and – the riskiest type of stocks – emerging market small-caps.

To form an optimal international asset allocation portfolio, the iShares Emerging Markets Dividend ETF is an excellent choice. This iShares asset allocation ETF also comes with moderate fees of 0.49%.

To achieve maximum growth of their capital, investors can allocate 95% of their capital to stock ETFs, with large caps still accounting for the majority of their investments. The remaining 5% of capital can be invested in global real estate in maximum growth global asset allocation ETF strategies.

Besides grouping asset allocation strategies by risk tolerance, investors can also form their optimal portfolio allocation based on their investment goals. Do you want to regular monthly income or maximum growth over the long run? Here are the main types of asset allocation models depending on your goal.

1. Growth-Oriented Strategies

As their name implies, growth-oriented strategies are designed for maximum growth of your capital over the long run. In those strategies, regular income is not a major concern as investors have enough funds to cover their regular expenses.

Since growth-oriented strategies have higher expected returns than other strategies, the majority of funds are invested in stocks. Large-caps still outweigh riskier stocks, but growth-oriented investors may also allocate a significant portion of their funds to younger companies with volatile prices and earnings.

2. Capital Preservation Strategies

In capital preservation ETF strategies, the major consideration is reducing the risk of even the slightest loss of capital. In addition, these investors pay a lot of attention to liquidity, which means they want to have access to their funds within the next 12 months.

Capital preservation strategies are heavily invested into very liquid money market instruments, government bonds, investment-grade commercial papers, and municipal notes. Fixed income can account for up to 80% of a capital preservation ETF portfolio. Since the 2008 Financial Crisis, interest rates on bonds and fixed income have been rather low, which made capital preservation models underperform most other tactical asset allocation ETF strategies.

3. Income-Oriented Strategies

In income-oriented strategies, regular income is the most important goal of the portfolio. These portfolios are designed to provide a steady and predictable income by investing in low-risk securities, which keeps the risk of losing money small.

Income-oriented portfolios invest primarily in fixed income securities, such as Treasury bonds and investment-grade corporate bonds, as well as in stocks of high-quality corporations (usually large-caps) that have a strong history of dividend payouts.

All of the mentioned asset classes are very liquid, which forms an excellent asset mix for income-oriented investors who want quick access to their funds. Given the low-risk characteristic and capped growth potential of income-oriented portfolios, they are best suited for investors who are risk-averse or want an effective asset mix in retirement.

A popular approach to select high-quality stocks for an income-oriented portfolio is to follow the criteria described by Benjamin Graham’s “The Intelligent Investor”. Here is a quick review of the criteria:

a.       Select large companies – Larger companies are usually more secure than smaller ones.

b.       Check financial conditions – The company should have a current ratio (total assets / total liabilities) of at least 2, which lowers the risk of bankruptcy.

c.       Earnings history – The company should have positive earnings in the last 10 years, at least.

d.       Dividend payments – Make sure the company has paid out dividends for the last 20 years and has preferably increased its dividends every few years.

e.       Stock valuation – The stock of the company should be overvalued in terms of the P/E ratio. Look for a P/E ratio that is lower than 15.

f. Earnings growth – Check if the company’s net income per share has increased by at least 1/3 over the last 10 years.

These criteria will allow you to select only high-quality stocks for the stock section of your income-oriented portfolio.

4. Growth-Income Balanced Strategies

Some investors may want to take the best of both worlds when it comes to growth-oriented and income-oriented allocation strategies. This is where growth-income asset allocation mix strategies come into play.

In a growth-income portfolio, an investor aims to create a portfolio that delivers both regular income and that has long-term growth potential. This portfolio is usually riskier than an income-based portfolio, but less risky than a pure growth-oriented portfolio.

A growth-income portfolio invests into fixed income, like Treasuries and high-quality corporate bonds. But, the growth comes from another asset class: stocks. Dividend-payment stocks that have a strong growth potential are the best choice for these portfolios.

While established brands are good enough for income-based portfolios, they don’t provide enough growth. Younger, riskier companies in industries that have a bright future are better suited for growth-income portfolios.

When to Rebalance an ETF Portfolio?

Once the investor builds his perfect portfolio based on one of the ETF asset allocation strategies mentioned above, the work is not done just yet. Investors need to rebalance their portfolios to meet changes in the world economy, local economy, his or her investment goals, and lifecycle.

For example, a growth-oriented portfolio may be a great choice for younger investors, but as the investor nears retirement age, a less risky income-oriented or capital preservation portfolio may be a better option.

Also, when certain asset classes underperform or outperform other asset classes, an investor may want to reduce the weight of the underperforming asset class, increase the exposure to the outperforming asset class, or lock in some of the profits to reinvest the proceeds according to another asset mix strategy.

Investors who want to actively manage their investments may follow the current business cycle and make respective changes to their ETF portfolios.

When the economy is booming, riskier asset classes tend to outperform safe-havens. This is the time when stocks reach new record highs, commodities enter a bull market, while fixed income securities fail to attract new buyers. Stock sectors also perform differently depending on the current business cycle, as can be seen on the following chart.

To cool down an overheating economy, central banks like the Fed will start to hike interest rates which makes money more expensive. As a result, business activity and investments slow down and consumer spending (loans) falls, which helps to keep inflationary pressures under control.

This is also the time when the stock market tends to peak and when interest in fixed income securities (bonds) starts to rise as higher interest rates make this asset class more attractive. Following the current business cycle by keeping an eye on leading indicators, such as PMI indices and the housing market, tremendously helps active investors in making better investment decisions.

Final Words

An asset allocation ETF portfolio helps investor meet their investment goals based on risk tolerance, investment horizon, and current lifecycle. In terms of risk tolerance, investors may choose from the conservative capital preservation strategies to riskier capital growth strategies, with the income-oriented strategies laying somewhere in between those two.

Capital preservation ETF asset allocation strategies are designed to provide maximum safety for investor funds. They achieve this goal by investing the majority of funds in safe asset classes, such as Treasuries and investment-grade corporate bonds. The remaining portion is invested in high-quality large-cap stocks.

Income-oriented strategies, as their name suggests, aim to provide a steady flow of income during the year. This is again achieved by investing in fixed income securities and government bonds with coupon payments, but also in high-quality stocks that have a proven track record of dividend payments.

Finally, growth-oriented strategies are designed to deliver maximum growth of the capital during the investment period. Those strategies are usually riskier than the other two as the majority of funds are invested in stocks, ranging from high-quality large-caps to small-caps, and even emerging market stock markets.

Markets are constantly looking for signs that indicate that the current economic climate is about to change. Those signs are usually provided by economic indicators which are regularly reported and closely followed by traders and investors around the world.

Metaphorically, depending on whether economic reports look at the economy through the windshield of a car, the side window, or the rearview mirror, they can be grouped into leading, coincident, and lagging indicators.

Leading Indicators: Looking Through the Windshield

Leading indicators are a group of economic indicators that are considered to lead overall economic activity, and can therefore be used to anticipate how future market conditions will look like. Despite their name, leading indicators are not always correct in their forecasting and should always be combined with other indicator groups or analytical disciplines when making investment decisions.

Here’re the most important leading economic indicators.

1. New housing starts

The number of new residential buildings that began construction is a powerful leading indicator. It’s usually reported as an annualized number and adds new housing starts for the previous month.

The report is highly correlated with the Building Permits report because a permit must be issued before the start of construction.

New housing starts and the number of issued building permits are widely followed by traders as they produce a ripple effect in the economy, including new jobs for construction workers and a higher demand for other construction services that are needed in house building.

A housing report that comes in better than expected is considered good for the economy, while a decrease in the number of new housing starts can spark recession fears. It’s also important to note that this is a cyclical indicator, as there are more new housing starts during summer months than during winter months.

2. Central Bank policies

Central bank policies are arguably the most important leading indicator in the markets. Central banks hold regular monetary policy meetings (typically every quarter) where they assess the current economic conditions and adjust their monetary policies to stimulate the economy, ensure full employment, and keep prices stable.

Central bank meetings are widely followed as they provide valuable clues about how the central bank views the future of the economy. If they feel the economy needs additional stimulus, central banks will often turn to quantitative easing and rate cuts. Conversely, if the economy is doing well and inflationary pressures are building up, central banks will hike rates to cool down economic activity.

While trading central bank policies is not an easy task, unexpected changes often lead to significant volatility in the markets.

3. Bond yields

Bonds yields are often used as a leading indicator for the economy. Since bond prices and yields are inversely correlated, lower yields usually indicate higher demand for safe government bonds which signals that investors aren’t willing to take on risks in the market. Conversely, higher yields may signal lower bond prices as investors are more willing to invest in riskier assets, such as stocks for example.

4. Money supply

Another important leading indicator is the money supply. This is a slightly more complex indicator to track, as numerous factors may influence the current supply of money.

Nevertheless, more money in circulation usually signals that consumers may be more willing to spend and businesses may invest in new production facilities and business expansion, which is considered good for the economy.

5. Capacity utilization

Capacity utilization refers to the extent to which a company uses its installed machinery and productive capacity. This indicator can also be applied to entire countries, where a higher capacity utilization usually translates into higher output and economic growth.

The optimal rate of capacity utilization is around 85%, as it allows companies and countries to quickly respond to higher demand by using their remaining productive capacity.

This is considered a leading indicator, as a higher rate of capacity utilization usually means a higher rate of future production and higher employment levels.

6. Consumer confidence

Another important leading indicator is consumer confidence. While there are many indicators that measure confidence and sentiment levels, the Conference Board’s Consumer Confidence Index is arguably the most popular one.

The index is based on a survey of around 3,000 households that rate the current and future economic conditions, such as the availability of jobs, business conditions, and general economic situation.

When people are confident in their current and future financial standing, they usually tend to spend more, which in turn increases corporate profits and economic growth. Traders who want to trade consumer confidence levels can do so by comparing the actual reported level with market forecasts.

7. Commodity prices

In some cases, the price of commodities can be used as a leading economic indicator. Take oil for example: When oil prices are high relative to historical prices, this usually means that there is a higher demand for oil as economic conditions have improved.

However, high oil prices can also signal an overheating global economy, and businesses that rely on the price of oil (such as airlines, for example) might see their profit margins plunge. Conversely, low oil prices help businesses increase their profitability, which can lead to economic expansion.

8. Stock indices

Last but not least, stock indices can also be used as a leading indicator of the economy. When companies are doing well and earnings beat forecasts, stock markets usually rally.

However, the price of stocks and the value of stock indices also discount future economic conditions, as perceived by investors and other market participants. If they think that economic growth will persist, stocks will rise, and vice-versa. That’s why following the stock market could be a good idea to get a feeling of how the economy might perform in the future.

Lagging Indicators: Looking Through the Rearview Mirror

Although lagging indicators usually “lag” current economic conditions, this doesn’t make them any less useful. Lagging indicators are often used to confirm that economic conditions have already changed (such as during economic recessions).

1. Unemployment rate

Labor market statistics are arguably the most important lagging indicator in the markets. The unemployment rate is a part of the labor market report and refers to the percentage of the total workforce that is unemployed but actively seeking employment.

Unemployment rates are usually reported on a monthly basis and markets pay attention to the difference between the actual number and the Street forecast. If the actual number misses expectations, the domestic currency and the equity markets usually fall. Conversely, if the actual number beats expectations (unemployment rate comes in lower than expected), the domestic currency and stock markets usually rally.

2. Average hourly earnings

The average hourly earnings are also a part of the labor market report. They refer to the price businesses pay for labor, with a higher number reflecting better economic conditions. In the United States, the Bureau of Labor Statistics releases all labor market numbers on a monthly basis, usually on the first Friday of the month.

An increase in average earnings can also be associated with lower unemployment rates, which in turn can lead to a gradual increase in prices as more money is chasing fewer goods and services.

When average hourly earnings come in better than expected, this is usually interpreted as good for the domestic markets.

3. Non-farm payrolls (NFP)

The non-farm payrolls, also known as NFP, is the most important piece of data related to labor market reports. The NFP is published by the US Bureau of Labor Statistics and refers to the change in the number of employed people during the previous month, excluding government jobs and the farming industry.

Just like other labor market reports, the NFP is usually considered a lagging indicator as it represents historical changes in employment levels.

Markets pay much attention to the NFP numbers. Traders stick to their trading platforms every first Friday of the month and wait for the NFP release at 13:30h GMT. Better-than-expected numbers usually cause enormous volatility in the markets and are considered good for the market. Conversely, a large miss in the NFP can send shockwaves and increase expectations of a future rate cut by the central bank.

4. Corporate earnings

Another lagging indicator is corporate earnings. Most companies report their earnings on a quarterly basis and include a public display of profitability, financial standing, and official comments on recent business performance. Publicly traded companies in the US are required to file those quarterly reports, as well as annual reports, 10-Q, and 10-K reports.

Corporate earnings are considered a lagging indicator as they’re based on a company’s past performance. Lagging indicators such as corporate earnings are often used to confirm a new business cycle, such as an economic slowdown or an upcoming recession.

Coincident Indicators: Looking Through the Side Window

Coincident indicators are used to clarify the current state of the economy and to confirm the development or reversal of a business cycle. They’re considered to track the current economic activity more or less in real-time.

Here’s a list of the most important coincident indicators.

1. Personal spending

Personal spending, also known as consumer spending, is a major coincident indicator that refers to the inflation-adjusted value of all consumer expenditures. Consumer spending typically accounts for around 70% of a developed country’s GDP and it’s one of the most important measures of economic health.

In the US, the Consumer Spending report is released by the Bureau of Economic Analysis, about 30 days after the month ends. However, the impact of the report on the markets can sometimes be muted because the Retail Sales report is released about two weeks earlier.

2. Retail sales

Retail sales measure the change in the total value of sales at the consumer level. It’s released by the US Census Bureau, around 13 days after the month ends. Given its timely release, retail sales are considered a primary gauge of consumer spending and overall economic activity in the reported month.

When retail sales miss market expectations, markets tend to react quite turbulently as retail sales play an important role in future economic growth.

3. Gross Domestic Product (GDP)

The Gross Domestic Product report, also known as GDP, measures the change in the total value of all goods and services produced in a country during a specific period of time. The GDP report is the broadest measure of economic activity and an important coincident indicator.

Still, the GDP report tends to have a muted impact on the markets because there are more timely reports that can be used to anticipate economic activity.

4. Gross National Product (GNP)

The Gross National Product (GNP) is quite similar to the Gross Domestic Product, with the main difference that the GDP also takes into account the net income from foreign investments. Just like the GDP, the GNP is a widely-followed coincident indicator that provides a broad measure of current economic conditions and activity.

5. Industrial production

Industrial production is another coincident indicator that measures the change in the total inflation-adjusted value of output produced by industrial manufacturers. It’s an important indicator that reflects the current economic conditions because production quickly reacts to changes in the business cycle.

6. Consumer Price Index

The Consumer Price Index, also known as the CPI, measures the change in the price of goods and services at the retail level. It’s a major inflation report as consumer prices account for the majority of overall price increases over a period of time.

Traders focus on the CPI report because central banks closely follow price changes in the economy. An increase in inflation can lead to higher interest rates, while a decrease in inflation can lead to rate cuts due to the central bank’s mandate to keep prices stable.

7. Producer Price Index

The Producer Price Index, or PPI, is another major inflation report that tracks price changes of finished and intermediary goods and services purchased by producers. The PPI report is usually released one business day after the CPI report, which makes its impact on the markets somewhat muted.

Nevertheless, traders pay attention to the PPI because an increase in the overall price level in the production process can sometimes lead to cost-push inflation.

In financial economics, there is a heated debate among academics over whether it’s possible to generate excess returns above the average market return. Because, if a group of traders or investors is able to outperform the general market, that market couldn’t be described as efficient.

That’s where the Efficient Market Hypothesis comes into play. Can you really outperform the market on a consistent basis or are markets fully efficient in reacting to all available news and information? Let’s find out in the following lines.

What is the Efficient Market Hypothesis?

The Efficient Market Hypothesis, also known as the efficient market theory, is a financial economics hypothesis that states that prices of financial instruments reflect all publicly and non-publicly available information and that generating excess risk-adjusted returns in the markets is thus impossible.

According to the EMH, it’s not worth trying to beat the overall market, and investors are better off investing in an index fund or ETF than trying to outperform the market.

The idea that it doesn’t make much sense to predict financial market returns goes back to the beginning of the 20^th century. More recently, the American economist Eugene Fama is often closely associated with the efficient market hypothesis due to his seminal work from 1970, “Efficient Capital Markets.”

What are Efficient Markets?

According to the Efficient Market Theory, financial instruments always trade at their fair value on exchanges. Since the prices of stocks, currencies, commodities and other asset classes reflect all available information, it’s impossible for investors to buy undervalued securities and sell overvalued ones. The theory states that it’s not worth trying to outperform the overall market, even though expert stock selection or various trading strategies.

The fact that many investors and traders consistently generate excess market returns is often dismissed by proponents of the EMH market theory. Those strong performances are often attributed to luck, as there will always be someone who outperforms the market and someone who underperforms the market (over a large sample size of market participants.)

In this regard, efficient markets are markets in which it’s impossible to beat the market, as all pieces of information are already discounted by the price – including non-publicly available insider information. Investors who want to generate excess market returns have therefore to invest in securities that carry higher risks, as this is the only way to obtain higher returns.

Criticism of the Efficient Market Hypothesis

Critics of the efficient market hypothesis, including famous investors like Warren Buffet and George Soros, have disputed the EMH market theory. In his 1984 presentation, Warren Buffet said that the preponderance of value investors who have repeatedly generated excess market returns rebuts the claim that luck is the reason behind that.

Here is a chart of the performance of value stocks vs growth stocks. A portfolio of value stocks has clearly outperformed a portfolio of growth stocks during the 1967-1977 period, and again in the early 2000s.

Another investor who more than doubled the average market returns for decades, Peter Lynch, argued that the EMH theory is contradictory to the random walk theory of prices. To recall, the random walk theory states that market prices move randomly and without a predictable pattern, making it impossible to predict future price movements. Although both theories are often taught hand in hand in business schools, the EMH theory proposes that prices are rational and based on all available information, which means they are not random.

The Australian economist John Quiggin has claimed that Bitcoin is a fine example against the EMH theory. According to Quiggin, the sky-rocketing price of Bitcoin isn’t supported by an underlying value of the cryptocurrency, which makes the uptrend basically a bubble. But, the efficient market hypothesis says that there shouldn’t be any market bubbles as prices are rational.

Random Walk Theory

The Random Walk Theory and Efficient Market Hypothesis are often cited together when discussing the efficiency of markets. The Random Walk Theory asserts that historical price information can’t be used to predict future price movements, as all prices have the same distribution and are independent of each other. In other words, yesterday’s prices can in no way affect today’s prices, and today’s prices can in no way affect tomorrow’s prices.

The Random Walk Theory suggests that, since all prices are random and unpredictable, market participants are not able to use any methods to anticipate future prices and make a profit. According to the theory, technical analysis can’t be profitable as trends can’t be consistently predicted. Likewise, fundamental analysis doesn’t help either as the quality of information is often poor and misinterpreted.

The name of the theory was coined in 1973 by Burton Malkiel and has faced a lot of criticism since then. Critics contend that markets often trade in strong and long-lasting trends and that traders and investors are able to take advantage of those trends by picking precise entry and exit points.

The Wall Street Journal tested the theory in its popular WSJ Dartboard Contest. In the test, journalists of WSJ threw darts to select a group of stocks and compared the results with the performance of professional money managers. The result – after more than 140 contests, professional managers won 87 times and the dart throwers 55 times.

Malkiel responded to the results of the test by explaining that stocks picked by professional managers received public attention, which then drove their prices higher. However, if markets were really random and efficient, those experts wouldn’t be able to beat a randomly selected group of stocks at all.

The Random Walk Theory is usually associated with the weak form of the Efficient Market Hypothesis, which will be discussed later in this article.

So, Can Markets Be Inefficient?

Despite the widespread use of the EMH theory among academics, most markets exhibit a certain degree of inefficiency. Market participants, including traders, investors, hedge funds, and banks, rarely have access to the same pieces of information and don’t act immediately on it. This creates a lag in the markets during which it is possible to generate excess market returns, dismissing the premise of the EMH theory that markets are efficient.

The following chart shows how stocks that are considered cheap according to P/E ratios have outperformed stocks that are considered expensive over a 10-year period.

Imagine a situation where market participants believe that gold could rise 10% in value over the next month. The price won’t shoot immediately to its target for a number of reasons, including human emotions, profit-taking activities, information asymmetries, and so on. Arbitrage opportunities would arise which would help the price on its way up, but in an efficient market, those arbitrage opportunities would be exploited immediately.

There are many reasons why most financial markets aren’t completely efficient. Here are the main ones followed by efficient market hypothesis examples:

· Low liquidity – The lower the liquidity in a market, the lower its efficiency. Liquidity refers to the number of buyers and sellers in a market who are willing to buy or sell at almost any price level. Highly liquid markets, such as Forex, are usually considered to be very efficient. Prices react very fast to new pieces of information and currency pairs quickly restore equilibrium, even after unexpected market news.

However, the Forex market is still not completely efficient as arbitrage opportunities and highly profitable trading setups still exist in this market. In addition, even the Forex market has some pairs that are less liquid than others, such as NZD/CAD for example.

An example of an illiquid market would be a penny stock or exotic currencies that don’t have many buyers or sellers. Those markets are considered to be very inefficient, as new news is discounted slowly in the price, and transaction costs are quite high.

· Transaction costs – Speaking of transaction costs, those costs bring inefficiency to a market. As a rule of thumb, the higher the transaction costs to open a trade, the less efficient that market is. Think of it this way: transaction costs need to be taken into account when participating in a market, such as when exchanging US dollars for euros for your next holiday trip, or when investing in the Australian dollar for carry-trade returns.

Transaction costs can make some market participants reluctant to immediately act on fresh news, which makes the absorption of new pieces of information slower than in a highly efficient market.

· Human emotions – The next reason why markets are inefficient is human emotions and behavioral patterns. According to the efficient market hypothesis, news and information are immediately discounted in the price, making it impossible to trade and make excess returns on them.

However, empirical evidence shows over and over again that this is rarely the case. Since most market participants are still human, we need to take into account that human traders have to deal with a range of emotions, such as fear and greed. Behavioral patterns that arise of those emotions form a delay between the moment the news hits the market, and the period when it gets fully discounted in the price.

Imagine a situation where Germany reports its new monthly PMI (Purchasing Manager Index) numbers. A number that comes in better than expected should have a positive impact on the euro, and a report that misses market expectations should have a negative impact on the currency.

The number came in better than expected, and the euro shoot higher against the US dollar. However, as a growing number of market participants start to act on the report and reposition their portfolios, the euro may keep trading higher for hours, or even days. Human emotions may further exaggerate the move, because of fear of missing out and greed.

· Information asymmetries – Last but not least, news and information are not equally accessible to all market participants, all the time. It takes time for traders and investors to digest new pieces of information, which forms a delay in price reaction. According to the EMH theory, there shouldn’t be a delay, as all participants have equal access to all important market news. However, in practice, that’s simply not the case. Non-public information and insider trading also add to inefficiencies in markets.

Similarly, let’s say news breaks out that the Fed may hike interest rates sooner than previously anticipated. A small group of traders and investors may be the first to get the news and act on it, followed by Bloomberg subscribers, and finally, retail traders who got the news on their Twitter feed. This information asymmetry doesn’t allow the price to immediately discount the new piece of information, and it may take hours until the news gets fully priced in by the markets.

Are Excess Returns with Trading and Investing Possible?

Many traders and investors have been able to consistently outperform the average market return. Warren Buffet’s Berkshire Hathaway has had an average annual return of 20% compared to the 10.2% of the S&P 500 since 1965.

Although there were years when the S&P 500 outperformed Berkshire Hathaway, it’s important to note that a good long-term strategy doesn’t have to beat the market every single year. Warren Buffet’s investment strategy is value investing, buying undervalued stocks and holding them for as long as possible.

Another famous investor, Peter Lynch and his Magellan Fund, averaged around 30% annual returns between 1977 and 1990, which made it the best-performing mutual fund in the world. Peter Lynch believed that smaller individual investors had a substantial advantage over large institutions because larger firms couldn’t invest in smaller companies for a number of reasons.

For example, their trading size would be inadequate for the average daily trading volume of small-cap shares, and strict risk procedures wouldn’t allow them to buy companies with a market capitalization below a certain threshold. Those reasons alone go against the EMH market theory, as large institutions aren’t able to act on all available information because of a number of restrictions.

This chart shows how $1 invested in the Magellan Fund would perform from 1977 to the 1990 when compared to the return of the S&P 500.

According to the EMH market theory, any investor who generates returns above the average market return is simply “lucky.” That’s why economist Phillip Pilkington has argued that the Efficient Market Hypothesis is actually a tautology or pseudoscientific construct because EMH proponents insulate the theory from falsification by describing investors who are consistently profitable as “lucky.”

Modifications to the EMH Market Theory

The original form of the EMH theory which says that all available information is immediately discounted by the market, making it impossible for traders and investors to outperform the average market return, is sometimes hard to digest. Empirical evidence showed that traders and investors can outperform the market for a significant period of time.

That’s why modifications of the EMH theory exist to reflect the true and practical nature of markets.

Here are the main forms of EMH.

· Strong efficiency – The strong form of EMH asserts that all available information is immediately reflected in a financial instrument’s price. Not even those with insider information can use it to gain an upper hand and make superior investment results. This is the standard form of EMH.

· Semi-strong efficiency – The semi-strong form of EMH asserts that current prices reflect not only historical price information but also all publicly available information of a financial instrument. This means that any type of fundamental or technical analysis won’t be able to generate outsized returns, including the analysis of balance sheets, income statements, earnings reports, and chart patterns. Only those with privileged information (insider traders) who have access to non-publicly available data are able to take advantage of that information.

· Weak efficiency – The weak form of EMH asserts that only historical prices are fully reflected in the current market price. This means that traders aren’t able to generate above-average returns using technical analysis tools, such as trendlines, support and resistance levels, and breakouts.

However, fundamental analysis could be used to generate excess market returns as not all available information gets immediately discounted by the price. It is this form of the EMH theory that is often associated with the “Random Walk Hypothesis.”

Final Words

The efficiency hypothesis is a popular theory that states that all publicly and non-publicly available information is immediately reflected in the price and discounted by the market, making it futile for market participants to aim for excess market returns. Therefore, any type of fundamental or technical analysis won’t be able to generate returns that are above the average market return.

Critics of the theory contend that there are many market participants who have been able to consistently generate high returns over a long period of time, like Warren Buffet’s Berkshire Hathaway, Peter Lynch’s Magellan Fund, Jim Simon’s Renaissance Technologies, and George Soros’ Quantum Fund. Besides those famous investors, a large number of individual traders and investors have also been able to reach consistent profitability in the markets.

Proponents of the efficient capital market hypothesis often reply that the main reason why a group of investors outperform the average market is luck. However, describing excess market returns generated over a period of decades simply as luck doesn’t give credit where it’s necessary.

To apply the efficient market hypothesis theory to the practical world of investing and trading, academics have made certain modifications to the original market efficiency theory. Besides the strong form of EMH, there is a semi-strong form that asserts that all historical prices and public information is already discounted in the price, but not non-public insider information. And there is the weak form of the EMH theory that states that only historical prices are fully priced in, but not new pieces of information.

Almost seven years have passed since June 2010, when China’s government indicated it would continue with financial reforms and make the renminbi exchange rate more flexible, satisfying major world economies and their leaders who believed the renminbi is excessively undervalued.

Is the renminbi moving towards a freely floating currency, is this the right path to go, and will it manage to find a place among the elite global reserve currencies?

Until 2009, economists agreed that, besides the U.S. dollar and Euro, the third global reserve currency in a multipolar reserve system could become either the Japanese yen or a kind of incorporated money, called the “Asian dollar”. With the growing Chinese economy, in line with the monetary and economic reforms conducted by the Chinese government, it is seen that the renminbi may become the Asian counterpart currency in the multipolar reserve system.

As of October 2016, the renminbi is included in IMF’s artificial currency, called the Special Drawing Rights, consisting of global reserve currencies such as the U.S. dollar, the Japanese yen, the British pound, and the euro. This is the first time a currency was added to the basket since the introduction of the euro in 1999. China’s central bank has already signed numerous bilateral currency swap agreements with central banks around the world.

The 2016 Triennial Central Bank Survey, conducted by the Bank for International Settlements, showed a significant rise in the importance of the renminbi in the currency markets. The renminbi became the eighth most actively traded currency, overtaking the Mexican peso.

Furthermore, the average daily turnover of the renminbi almost doubled between April 2013 and April 2016, from 120 billion $ to 202 billion $. The USD/CNY currency pair moved up from ninth to sixth place among the most traded currency pairs, with a daily average turnover of 192 billion $. Analysts agree that this trend will persist in the future.

The renminbi is also more and more used in international trade agreements, with prospects showing the Chinese currency may become the second most used currency after the U.S. dollar by 2020. Multinational companies are already issuing bonds denominated in renminbi, showing that the trust in the currency rises steadily in recent years. This is an important sign of improving international acceptance of renminbi, otherwise, companies would issue bonds denominated in other currencies, and hedge their exposure with financial derivatives.

There is no doubt that the renminbi has come a long way since the Chinese government started with reforms in the domestic financial markets, easing capital restrictions on inflows and outflows. But, there remain significant hurdles for the Chinese currency to become truly internationally accepted as a global currency.

Although China is making some necessary steps in liberalizing and regulating its financial markets, they still seem weak and are lacking regulatory oversight compared to financial markets of advanced economies. International investors are still not quite impressed with the actions of Xi Jinping’s government, which has rolled back the rule of law and the independence of key state institutions from government interference.

At the World Economic Forum Annual Meeting in Davos, Switzerland, Chinese President Xi Jinping reaffirmed his country’s “open door” policy and pledged never to benefit from the devaluation of the renminbi. On the other side, the new president of the United States, Donald Trump, has accused China of intentionally devaluing its currency to gain export competitiveness. It is claimed that the renminbi is undervalued by as much as 37% against its purchasing power parity.

In reality, China had a tough time battling with downward pressure on its currency and trying to keep the USD/CNH exchange rate stable. As exports are falling, China’s current-account surplus fell to just 2.1% of GDP in 2016. Economists are predicting the surplus to fall further as exports continue to fall.

Also, as China recently shifted to a growth model including higher domestic consumption, opposite to an export-driven model, a weaker renminbi is not quite the path China wants to take. Reports about declining investments and exports have put downward pressure on the Chinese currency which has weakened significantly in recent years, from 6.05 to almost 7.00 USD/CNH.

While the recent rise of renminbi’s importance in global trade and financial markets cannot be denied, forecasts about an absolute dominance of either the renminbi or the U.S. dollar will most likely prove to be wrong.

With prospects of overtaking the United States as the largest world economy, China needs inevitably to accelerate the pace of market and state-related reforms, improving the trust of international investors in its currency. Switching to a free-floating currency, in the foreign-exchange market heavily dominated by the U.S. dollar, would increase the volatility of the USD/CNH pair which is not beneficial for China in the moment. A managed float of the renminbi is most likely to stay in the near future.