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A strong dollar amplified the recent stock and commodity swoon--and I don't think (oddly enough) that we're done with the strong dollar yet
09/30/2011 8:30 am EST
I’d argue that over the last two weeks to a month, the rising dollar has been the most under-appreciated driver of stock prices. And the weeks ahead are setting up the dollar, the euro, the Chinese renminbi, and the Brazilian real as big market movers. The reversals and the rallies of the next month are likely to signaled by, related to, and amplified by currency moves.
Watch carefully if you want to catch the next rally—and avoid getting blindsided by the next reversal.
Look at the dollar’s climb against global currencies from August 30 to September 27. During those four weeks the dollar gained 7.7% against the euro, 8.8% against the Australian dollar, 9.0% against the Norwegian kroner, and a whopping 15.4% against the Brazilian real. Even the Chinese renminbi lost ground to the dollar, as Beijing let the current slide to a 3.6% decline versus the dollar.
The Why? is pretty simple. When the world gets riskier—or investors and traders perceive it as getting riskier—the world buys dollars. Now this might not make sense to you if you have a long-term view of the world and are worried about little things like the U.S. annual budget deficit, soaring government costs for healthcare, and slow economic growth. But if your time frame is days or weeks or months instead of years, the U.S. dollar is a great haven: U.S. markets are very liquid so it’s easy to get in and out; the Federal Reserve has promised no interest rate increases until mid-2013 so there’s no risk that higher rates will bite into the value of your dollar assets; and, again hard as this may be to believe, U.S. macroeconomics and politics is more stable, in the short run, than those of the EuroZone (well, duh!) or Brazil (run-away inflation) to take two examples.
The effects of this dollar appreciation would have been significant if the gains in the U.S. currency had been spread over a year or 18 months. Taking place over just the course of a month, dollar appreciation moved markets big time. A rising dollar sent commodity prices falling. (Not as if they needed any help what with fears the global economy (read China) was slowing. See my post from September 27 on why only China matters http://jubakpicks.com/2011/09/27/how-fast-china-grows-in-2012-and-worries-about-that-growth-rate-are-what-will-count-for-stocks-no-matter-what-happens-over-the-next-few-weeks-in-europe-and-the-united-states/ ) The price of copper, for example, fell by 17.6% from August 30 to September 27.
And a rising dollar and falling commodity prices sent commodity stock prices plunging. For example, shares of copper and gold miner Freeport McMoRan Copper & Gold (FCX), a Jubak’s Pick http://jubakpicks.com/ , dropped by 25.3% during this same four-week period.
Which meant for emerging stock markets a barrage of negative pressure. Currencies pushed share prices down. Commodity prices pushed commodity-intensive economies and their share markets down. Commodity stocks, often among the stocks with the largest market capitalization on these markets, piled on the downward pressure. No wonder the Brazilian stock market (measured by the iShares MSCI Brazil Index), already down 21.6% from its April 1 high to August 30, would tumble another 13.3% by September 27.
The wonder, actually, was why it wasn’t down more.
This is all history. The question is Where do we go from here?
So much in the currency markets depends on the euro debt crisis, as William Carlos Williams might have written. If the financial markets feel that the EuroZone hasn’t so much ended the crisis as reached a truce with it, the euro will at least stabilize against the dollar—at least until the crisis next rears its head in December or so when Greece has to make big payments to bond holders. Currencies that are fundamentally stronger than either the dollar or the euro would climb in any truce because cash wouldn’t be quite so single-minded in its search for safety. Commodities and commodity stocks would get a dual boost from a lower fear quotient and from any decline in the dollar.
But you can’t reduce the moves ahead in the currency markets to one all-dollar/euro, all-the-time cause.
For example, there’s the question of whether China will freeze the dollar/renminbi exchange rate as it did in July 2008. Beijing took that step back then to give its financial markets and economy shelter from the global market chaos. With 2011 reminding a number of people of 2008 and the threat to the global financial system in that year, a renminbi/dollar freeze would seem a reasonably likely event. An appreciating renminbi against the U.S. dollar would give some boost to the U.S. economic recovery since it would make U.S. products cheaper in China—a frozen exchange rate would remove that boost. A renminbi pegged against an appreciating dollar would actually make China’s exports more expensive in non-dollar countries and give those countries an edge in exporting to China. That would be a plus for a country such as Brazil. China might well be willing to pay these costs, though, to gain insulation from the global financial chaos, especially as Beijing is worried about the balance sheets of its own big banks.
And speaking of Brazil, the value of the real is more likely to be set by internal developments than by what happens with the dollar or renminbi. By lowering it benchmark Selic interest rate to 12% from 12.5% in August before seeing a drop in inflation that hit an annual rate of 7.33% in September, the Banco Central do Brasil placed a huge bet on the global economic slowdown cutting the prices of imports and commodities enough to get inflation in early 2012 down below the central bank’s upper range of 6.5%.
I don’t think that’s going to happen because so much of the pressure driving Brazilian inflation is now internal wage pressure. For example, on Tuesday September 27 the country’s bank workers staged a strike over pay. In their strike, following strikes from postal workers and metal workers earlier in September, bank workers are demanding a 13% pay increase. Workers feel squeezed by the country’s current 7.33% inflation and the drop in the value of the real just makes the pain worse since it increases the cost of imports to Brazilian wage earners. Maybe the central bank will get lucky, but I think that breaking inflation in Brazil now is going to require painful cuts in government spending and a return to a policy of interest rate increases.
The great currency wildcard, one that you probably haven’t thought about in a while, is Russia’s ruble. The Russian central bank has been active in the currency markets lately buying rubles with $2 billion spent on Monday, September 26, alone. The problem is that Russia’s finances are a mess especially after the government has upped spending to increase the military budget and to put more cash into social programs. (It’s called Buying off social protest.) With the new spending the Russian budget, which is heavily dependent on oil revenues, doesn’t balance unless oil sells for $120 a barrel. Not likely in 2012. (Benchmarks West Texas Intermediate closed at $81 a barrel and Brent at $103 a barrel on September 28.) I think there’s a real chance of a cut to Russia’s credit rating in 2012 and an outside chance of a ruble crisis.
My conclusion from all this is that while I can make a case for a short-term decline in the U.S. dollar against the euro and other currencies such as the Norwegian kroner and the Australian and Canadian dollar over the rest of 2011—if the euro crisis moves from a rolling boil to a simmer—I find it very hard to make a case that the dollar won’t regain its safe haven boost in at least the first half of 2012.
Nothing coming out of Europe convinces me that we’re going to see a real solution to the Greek debt crisis this month or even the creation of a credible firebreak to prevent the crisis for moving to Italy. Without that solution and firebreak financial markets could take a break from the Greek crisis that might be long enough to fit in an end of the year rally. But investors can expect a return to the crisis in December, when Greece needs another cash infusion (this time to pay bondholders). I don’t see a way out of the crisis except the creation of a financial guarantee fund of a size that looks to be politically impossible in Germany, Finland, and the Netherlands, or default by Greece.
I think it’s safe to assume that a return to the debt crisis with a Greek default as a much clearer part of the end game would not be good for the euro and would cause cash to flow into the dollar.
That won’t be good for global commodity prices or for the currencies of emerging economies or for developed economies with ties either actual or merely geographical to the euro. This trend will make it especially tough on developing economies and emerging markets such as Brazil and Russia that are facing big internally generated problems as well.
Will there be any place to hide from this dollar-up/everybody-else-down current trend? Maybe in what I’d call the China currency block. There are a group of global currencies so linked to the Chinese economy—the Australian and Singapore dollars (sorry Canada but too much of your economy is linked to that of the United States) come to mind--that cash flows in and out of the dollar are less important for the value of their currencies than the growth rate of the Chinese economy.
As long as investors aren’t sure what China’s growth rate will be when it bottoms in 2012, then I think it will be hard for these currencies to detach themselves from the global dollar trend. But as soon as it is clear—maybe mid-2012—how slow China will go, then I think these currencies and economies will—with China—wind up dancing to their own tune and not that of the global trend.
When that happens, if it happens, those will be the best performing currencies (except for the dollar-pegged renminbi) and stock markets in the world.
So what do you do about all of this?
- Profit from the end of the year rally—if we get one—by picking commodity-related stocks that have been crushed recently. (I recently recommended Jubak’s Picks member Freeport McMoRan Copper & Gold (FCX) for this purpose. http://jubakpicks.com/ ). Add a dose of crushed technology shares such as my recent Jubak’s Pick of F5 Networks (FFIV) http://jubakpicks.com/2011/09/28/buy-f5-networks-ffiv/ And maybe a dollop of stocks outside the EuroZone that have been killed along with the euro. Take a look at Norwegian fertilizer company Yara International (YARIY), for example. We should have a better sense of the chances for a year-end rally when we see, in coming days, how financial markets react to the newest temporary fix in the Greek crisis and to the earnings season that starts on October 11.
- Sell into the rally in order to raise cash for the first half—roughly--of 2012. The goal here is to have a supply of dry powder—it’s okay if you keep it dry by investing in gold (if the yellow metal stabilizes) or less-volatile high-yield stocks—so that some time in the first half of the year, if the dollar rally resumes, you’ll have the cash to pick up the fundamental bargains that the dollar rally will create in commodities and commodity-related stocks, and in assets denominated in temporarily depressed currencies. For example, I’d love to pick up Australian stocks if I can pay for them in temporarily over-valued U.S. dollars. Over time I’ll get not just the appreciation in the underlying stock but in the currency too.
- Wait patiently (or impatiently—but just wait) for evidence that the market is starting to see a bottom in China’s growth rate. You don’t need to pick the absolute moment in 2012 when the market psychology changes. You’d just like to avoid taking too much punishment while you wait for a turn.
Will executing any one part of this strategy—let alone all three--be easy? No way. It will demand more patience that I can usually muster and the grace to forgive my mistakes so I don’t do something really stupid out of regret or anger.
But from all I can see managing your market exposure and your cash (or cash surrogate) positions will be the key to investing in the rest of 2011 and in the first half of 2012.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Freeport McMoRan Copper & Gold and Yara International as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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