There is still some upside left in the XLF as we head into 2018, yet I think there is greater risk i...
The sky isn't falling and the dollar isn't going to zero. Yes, the dollar is in a slow and long-term decline but don't buy what the panic mongers are selling
10/20/2009 8:30 am EST
There’s denial, anger, bargaining, depression, and finally acceptance.
The financial markets when confronting a strong trend work through their own five stages. Not of grief. But of enthusiasm. And you know that the trend is nearing an end when we reach Stage Five, acceptance.
Or as I call it, “I’ve got to have a piece of that.”
I think we’re now moving to Stage Five in the trend I call the collapsing U.S. dollar. That doesn’t mean this trend is going to end over night. Trends always run to excess and then beyond. (As Elvira says to Tony Montana in Scarface, “Nothing exceeds like excess.”)
But it does mean we’re getting to the point where the easy profits are gone and the risk starts to rise.
Here are my five stages of investing trend enthusiasm.
- Denial. The trend isn’t real. And it’s certainly nothing an intelligent investor would put a dollar in.
- Skepticism. Okay, there may be something there but I’m not convinced.
- Bargaining. Okay, the trend is real, but isn’t it too expensive and too risky to invest in now?
- Anger. God, I’ve missed it. The time to get in was three months ago.
- Panic. The trend is real; the risks are overstated; it will go on forever; I’ve got to buy in.
And, of course, if you’ve been investing for a while your portfolio has the wounds that show how dangerous it is to buy into a trend when everybody believes they must get in. (The smartest money is usually headed to door at just about that point.)
It’s not necessarily time to abandon a trend when it reaches Stage Five, but it is a time to start trimming rather than pouring new money into the market. And it’s a time to think very, very carefully about what stocks and other vehicles you use to ride the last stages of this trend.
I think we reached that point with the falling U.S. dollar. The dollar is down about 9% against the euro since January and about 11% against a trade-weighted basket of currencies.
And the damage is even worse against what I’d call the world’s commodity currencies. So, for example, the dollar is down 16% in 2009 against the Canadian dollar, 24% against the Australian dollar, and 27% against the Brazilian real.
I think there are good reasons for the decline. The U.S. consumer is in a deep, deep hole. Households owed 127% of disposable income at the end of 2008, according to the Federal Reserve. To get that ratio down to 91%, the average from 1990-2000, households would have to shed $4.4 trillion in debt.
Government debt has soared as a result of the fixing the financial crisis and stimulating the economy. And the federal budget wasn’t in great shape to begin with given huge unfunded liabilities in healthcare and retirement programs. The percentage of Federal debt held by the public is projected to go from 41% of GDP in 2008 to 68% by 2019.
And this isn’t the dollar’s only problem. The U.S. economy has been slower coming out of the economic slowdown than China India, Brazil, Australia, France, Germany… well, the list goes on and on. Interest rates in many of those countries are already higher than in the United States and in some—Australia, for example—central banks have already started to increase interest rates.
Let’s see slower growth and lower interest rates—sure makes me want to put my money anywhere but in U.S. dollars.
Once a currency goes into a fall like the dollar’s recent plunge the trend feeds on itself. The dollar goes down (or just threatens to go down) and no one wants to risk owning dollars, which makes the dollar go down, which makes fewer people want to own dollars.
And it takes a pretty big shock to reverse this kind of self-reinforcing move. In my October 14 post http://jubakpicks.com/2009/10/14/know-what-to-worry-about-and-when-if-you-dont-want-to-get-spooked-out-of-a-rally-or-get-killed-in-a-correction/ I laid out the case that the downward trend for the U.S. dollar will continue until sometime around the middle of 2010 when the Federal Reserve makes it clear that it is on course to start increasing short-term U.S. interest rates from their level near 0.25%.
But to go from a “The U.S. dollar is likely to slide lower over the next six to nine months” to “The dollar is going to fall another 50%” or “The dollar is worthless” to me smacks of Stage 5 panic.
When I hear this kind of stuff, it makes me want to start cutting back on commodity-related and emerging market stocks. (I’m apparently not the only one to have these thoughts, an email from reader Terry W. points out. Analysts who have cranked through Goldman Sachs’s (GS) recently released third quarter earnings believe they detect signs that Goldman is getting less bullish on commodity prices just when competitors such as JPMorgan Chase (JPM) are getting more aggressive.)
Want to, mind you. I’m not taking any action yet. (But although I don’t use stop loss orders in Jubak’s Picks because maintaining those orders is just so time-consuming for me, putting actual or mental stops 8% of so below the current price of some of your most volatile stocks and ETFs strikes me as a useful tactic here.)
But I am getting more vigilant.
What kinds of things am I hearing that send up red flags?
Analysts like Bill Fleckenstein and Jim Grant don’t bother me when they call the dollar worthless. That’s been their position since they were old enough to feel cheated when the price of Batman went from 10 cents to 12.
What smacks of dollar panic is when we get voices that are normally bullish—and remember that Wall Street is almost always bullish since its job is to raise money by selling things like stocks and bonds—jumping on dollar is worthless bandwagon.
How’s this from Daisuke Uno, chief strategist at Sumitomo Mitsui Banking: “The U.S. economy will deteriorate into 2011 as the effects of excess consumption and the financial bubble linger,” he said. “The dollar’s fall won’t stop until there’s a change to the global currency system.” He finished by saying the dollar may drop to 50 yen next year and eventually lose its role as the global reserve currency.
Well, eventually is a long time (As Keynes noted, in the long run we’re all dead), but 50 yen to the dollar? That’s a drop from today’s exchange rate of 90 yen to the dollar or about 45%.
Against the yen? Japan is the most indebted developed economy in the world with a government debt that at the end of 2008 ran to 170% of GDP. (The U.S. ratio, remember was shocking at 41% and horrifying at 68% in 2019.) This is one of the oldest populations in the world and a country with a dysfunctional political system that pumps money into underproductive rural areas because they have a disproportionate electoral clout.
And the dollar is supposed to fall 45% against the yen? When it has remained essentially flat against the dollar during all the U.S. troubles in 2009? (To put the U.S. debt problem in a global and historical perspective, see Sherle Schwenninger’s paper for the New America Foundation http://www.newamerica.net/files/9-15-09%20debt%20overhang.pdf )
Feels like jumping on the band wagon in panic, Mr. Chief Strategist.
You’ve been through Stage 5 trends before if you were investing in 1999 and 2000.
Remember the collapse of all reason as Wall Street analysts competed to see who could put the highest target price on Amazon.com (AMZN) and AOL. $500? Do I hear $600? How about $1,000.
I can hear the same panic in the current bidding to see who can set the highest price on gold. Not so long ago the consensus was that $1150 an ounce or so might be a top for gold. That’s been left in the dust. As has $1200 an ounce. And you don’t have to look very hard to find analysts calling for $1500. Next year. That’s a 50% climb in the price of gold. Think about it.
So what should you do?
If you hold stocks or other assets that benefit from the rising belief in the falling value of the U.S. dollar, hold on. It wouldn’t hurt to set either actual or mental stop loss targets 8% or so below current prices for these volatile investments.
If you’ve missed the falling dollar rally to date, don’t do anything stupid. A prediction that the dollar will tumble 50% more isn’t a good enough reason to load up on anything. I think the dollar has months of decline ahead of it, but the decline is likely to be relatively gentle. Remember that when we’re talking about the BIG drop in the dollar in 2009, we’re talking about 11%.
You could have done way better than that by simply forgetting about the dollar and just buying a Standard & Poor’s 500 stock index fund or an ETF that tracked the technology sector.
If you must buy something to play the falling dollar, try to stick with investments that have real fundamentals behind them. Buying the iShares MSCI Brazil ETF (EWZ) or Market Vectors Brazil Small Cap ETF (BRF), a Jubak’s Pick, for example, gives you exposure to a falling U.S. currency and, more importantly in my mind, a chance to profit from fundamental improvement in the Brazilian economy.
All market trends run to excess. But that doesn’t mean you have strap on your track shoes.
Full disclosure: Jim Jubak owns shares of iShares MSCI Brazil ETF and Market Vectors Brazil Small Cap ETF.)
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