Five Steps to Losing Your Money

10/20/2009 9:38 am EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

Market trends tend to pass through stages that lead to panic buying by investors desperate to get in on the action. Are you itching to profit from the falling dollar?

Be careful.

When the financial markets experience a strong trend, investors tend to pass through five distinct emotional stages:

  1. Denial. The trend isn't real. Or it's nothing an intelligent investor would put a dollar in.
  2. Skepticism. OK, there may be something there, but it's too risky.
  3. Bargaining. The trend is real. I'll invest, but only if the price is right.
  4. Regret. God, I've missed it. The time to get in was three months ago.
  5. Panic. This trend will go on forever. The risks were overstated. I've got to buy in.

We're now moving to stage five in the so-called collapse of the US dollar, which means this trend is actually nearing an end. That doesn't mean it's going to end overnight. Trends always run to excess and beyond. It does mean we're getting to the point where the easy profits are gone and that the risk is starting to rise.
And 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 the door at just about that point.)

It's not necessarily time to abandon a trend when it reaches stage five, but it is time to start trimming, rather than pouring in money. 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.

How Far the Dollar Has Fallen

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 about 16% in 2009 against the Canadian dollar, 24% against the Australian dollar, and 27% against the Brazilian real.

There are good reasons for the decline:

  • The US consumer is in a deep, deep hole. Households owed 127% of disposable annual income at the end of 2008, according to the Federal Reserve. To get that ratio down to 91%, the average from 1990 to 2000, households would have to shed $4.4 trillion in debt.


  • Government debt has soared during the financial crisis, and the federal budget wasn't in great shape to begin with, given huge unfunded liabilities in health care and retirement programs. The percentage of federal debt held by the public is projected to go from 41% of the gross domestic product in 2008 to 68% by 2019.


  • The US has been slower coming out of the economic slowdown than China, India, Brazil, Australia, France, Germany, and 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.

When a currency goes into a fall like the dollar's recent plunge, the trend starts to feed on itself. The dollar goes down (or just threatens to go down), and no one wants to risk owning dollars, which makes the dollar sink further, which makes fewer people want to own dollars.

And it takes a pretty big shock to reverse this kind of self-reinforcing move. In an October 14 post, I laid out the case that the downward trend for the US dollar will continue until sometime around mid-2010, when the Federal Reserve makes it clear that it is on course to start increasing short-term US interest rates from today's level near 0.25%.

How Much More Can it Fall?

But it's one thing to say the US dollar is likely to slide lower over the next six to nine months and quite another to say that the dollar is going to fall an additional 50% or is worthless. That sounds like stage five panic to me.

When I hear this kind of stuff, it makes me want to cut back on commodity-related and emerging market stocks.

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I'm apparently not the only one to have these thoughts, an e-mail from reader Terry W. points out. Analysts who have cranked through Goldman Sachs' recently released third-quarter earnings believe they detect signs that Goldman is getting less bullish on commodity prices just as competitors, such as JPMorgan Chase, are getting more aggressive.

I'm not taking any action yet, but I am becoming more vigilant and looking for the kinds of comments that send up red flags.

But What About the Warnings?

It doesn't bother me when analysts such as Bill Fleckenstein and Jim Grant call the dollar worthless. That's been their position since they were old enough to feel cheated when the price of Batman comics went from 10 cents to 12 cents.

What smacks of dollar panic is when we get voices that are normally bullish—and remember that Wall Street is almost always bullish—jumping on the "dollar is worthless" bandwagon.

Such as these comments from Daisuke Uno, the chief strategist at Sumitomo Mitsui Banking: "The US economy will deteriorate into 2011 as the effects of excess consumption and the financial bubble linger. The dollar's fall won't stop until there's a change to the global currency system."
 
Uno 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, but 50 yen to the dollar? That's a drop of about 45% from today's exchange rate of about 90 yen to the dollar.

The Yen? Really?

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. It has one of the oldest populations in the world and is a country with a dysfunctional political system that pumps money into underproductive rural areas because they have disproportionate electoral clout. (The US ratio, remember, was shocking at 41% last year and is projected to be a horrifying 68% by 2019.)

And the dollar is supposed to fall 45% against the yen? When the yen has remained essentially flat against the dollar during all the US troubles in 2009? That feels like jumping on the bandwagon in panic, Mr. Chief Strategist.

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 $1,150 an ounce or so might be a top for gold. That's been left in the dust. As has $1,200 an ounce. And you don't have to look very hard to find analysts calling for $1,500. Next year. That's a 50% climb in the price of gold. Think about it.

Looking Ahead

So what should you do?

If you hold stocks or other assets that benefit from the rising belief in the falling value of the US dollar, hold on. It wouldn't hurt to set 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. The dollar has months of decline ahead of it, but the decline is likely to be relatively gentle. 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 Index fund or an exchange traded fund 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 the Market Vectors Brazil Small-Cap ETF (BRF), a Jubak's Pick, for example, gives you exposure to a falling US currency and, more importantly, 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.

At the time of publication, Jim Jubak owned or controlled shares of the following funds mentioned in this column: iShares MSCI Brazil ETF and Market Vectors Brazil Small-Cap ETF.

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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