Playing Chicken With The Dollar
Both Ben Bernanke and Tim Geithner are talking around the 800-pound gorilla in the room: the dollar. Bernanke made no reference to it in his discussions regarding the economy, as he focused upon the very low inflation and employment rates. The Fed solution is to embark upon further monetary easing, or putting additional dollars into the financial system. At the G-20 conference of finance ministers in South Korea, Geithner indicated that it is in the best interest of the US to have a strong currency, BUT it would be really nice if the Chinese would allow their currency to depreciate. While acknowledging that a country cannot depreciate their way to prosperity, the policies of the US are having the effect of depreciating the dollar. The consequences of the lower dollar have been showing up in commodity prices, from oil to gold and from grains to cotton. Also, as earnings have been coming in, those companies with large overseas revenues are doing very well vs. those focused primarily on domestic markets. Even the multi-nationals, in their comments to analysts, are highlighting the better international environment vs. domestic economy. Ultimately investors will become very nervous about this international game of chicken.
Another week, another gain and the markets continue to look like they are in need of a breather. While stocks did decline dramatically on Tuesday, those losses were erased quickly as investors dismissed the Chinese rate hike and looked instead toward further easy monetary policy in the US. Many of the momentum indicators are at high levels, both on a daily and weekly basis, however the net number of advancing stocks continues to trudge higher. Until the markets are driven higher by few issues (higher market, lower net advancing stocks), whatever decline occurs in stocks is likely to be rather short-lived. One other big of good news is that rotation has begun to take place in stocks, as investors sell off groups that have been doing well and rotating toward different groups. This rotation allows the markets to “self-correct”, keeping the overall averages moving higher, led by different groups. We are seeing signs of fatigue in some former leaders, like utilities and telecom and renewed leadership in materials and consumer cyclical stocks (think retail). As demonstrated during Tuesday, the market remains susceptible to dramatic and short-term declines, however until proven otherwise, the slow, steady rise in stocks is likely to continue.
Bonds continue to gyrate wildly around roughly 2.5% on the 10-year bond. Investors are seemingly comfortable accepting this return in what many are starting to believe is a Japanese style economic malaise that could last yet another 10 years. The key to the complacency is the still high and suffocating debt that is being carried by the government and investors alike and an insistent Fed that will push additional dollars out the door in the weeks ahead. The dollar has a role in this as well, as a lower dollar is making many good more expensive (see above), creating inflation in various parts of the economy, while none seems to exist in others. We are beginning to see some companies announce price increases in goods/services that may be the tip of the inflation iceberg that could make fixed income investing very treacherous in the years ahead.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.
About Paul J Nolte CFA
Paul J Nolte CFA Archive
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