|Thunder and Lightning|
By Todd Harrison NOV 14, 2007 7:52 AM
While mainstay proxies remain higher for the year, those actions have seemingly backfired in a big, bad way.
The wheel is turning and you can't slow down,
You can't let go and you can't hold on,
You can't go back and you can't stand still,
If the thunder don't get you then the lightning will.
--The Grateful Dead
The U.S. dollar is dominating the news as investors grapple with the realization that our basis of investment is eroding. Ben Bernanke got an earful from politicians on Capital Hill last week. Gisele Bündchen has reportedly demanded to be paid in anything other than dollars. Heck, even Jay-Z is flashing fistfuls of Euros in his most recent video.
Politicians piling on? Supermodels turned speculators? Rappers delighting in the benefits of foreign currencies? That can only mean one thing—the greenback is poised for one heck of a counter-trend rally.
Before you rejoice in that potential redemption, it would be wise to weigh the implications of what a higher dollar might mean for investors.
The greenback is down 37% over the last five years and that rising tide facilitated rallies across the supply-demand continuum. We call that lens “asset class deflation vs. dollar devaluation” and policy makers have clearly opted for the latter since the structural imbalances began to percolate on the back of the tech bubble.
'Buy time for a legitimate economic recovery to unfold,' they must have thought at the time, 'and we’ll goose the process with fiscal and monetary stimuli until it does.' And if that doesn’t work, we’ll try some financial engineering. Adjustable-rate mortgages might turn the trick, particularly if endorsed by someone as credible as Alan Greenspan.
And if that fails? There are other ways to shape psychology and affect perceptual change. Some were traditional measures. Others were not.
This has been a stealth process for stateside investors but it has not gone unnoticed by foreign holders of dollar-denominated assets. Still, it continues to manifest as equities, metals, crude and agricultural commodities lift in kind to offset the steady dollar depreciation. And nobody really seemed to care until the Federal Reserve cut rates in an attempt to stem the credit contagion that seized the system this summer.
Policy makers understand how high the stakes are in the current finance based economy, as do central banks around the world. They’ve postured, positioned and proffered assurances, pulling out all the stops in an attempt to flush the system with liquidity despite clear and present dangers.
While mainstay proxies remain higher for the year, those actions have seemingly backfired in a big, bad way. We now have inflation in things we need to feed, power and educate the world and deflation in things we want such as cell phones, laptops and plasmas. It’s called stagflation*, which is to say that we’ve seen this dynamic before but historical precedence need not apply.
The question, quite naturally, is whether the comeuppance has finally arrived or if this too shall pass as we push water with a fork. We’ve witnessed various gut checks this year and, by definition, a correction doesn’t serve its purpose unless the masses believe that something more ominous is afoot.
The trick to the current trade is to view the intricate market machination through the proper lens. On Monday, when the dollar rallied one percent, gold got hit for $40 and crude was off 3%. Yesterday, as the greenback gave back some gains, equities raced from the gate like kids from a classroom.
In this environment, while there are relative winners and secular trends, asset classes are trading as a monolithic monster on the other side of the dollar. How else can we explain the buoyancy of stocks in the face of triple digit crude? The answer seems to be staring us in the face and that sword cuts both ways.
That’s not to say that this will play out each and every session—it surely won’t—but the history of this dynamic, coupled with the cumulative stakes, warrants a deeper discussion as we toggle between the two.
For when the models and bottles crowd starts betting against the buck, chances are that they won’t be left with the tab.
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