Jeff Saut Presents: Bull or Bear? You Pick It!
All of a sudden you get the feeling that the plane is moving forward.
So, we can say that, yes, the Dow has been in a bull market since October 2002 in dollar terms. But it has been in a bear market in gold terms. This is an important point to understand. In case we should experience continuous monetary inflation, which could lift, over time, all asset prices such as stocks, real estate, and commodities, some asset classes will increase more in value than others. This means that some asset classes while rising in value could deflate against other asset classes, such as happened with the Dow against gold since year 2000. I have pointed out in earlier reports that since 2002, all asset prices rose in value. But recently, some diverging performances emerged. Bonds started to decline and seem to be on the verge of a significant long-term break down. I have also mentioned in earlier reports that, in times of monetary and credit inflation, such as we have now in the U.S., bonds are the worst possible long-term investment.
Another asset class which has recently begun to depreciate against gold is home prices. Since last summer, home prices, while only declining moderately in dollar terms, have declined significantly in terms of gold. So, whereas it took over 500 ounces of gold to buy a typical house in the U.S. last summer, now, it only takes around 380 ounces of gold. In other words, home prices have declined over the last nine months by 25% against the price of gold! What I really want every reader to understand is that bull and bear markets are extremely complex and an asset class which seems to be in a bull market may not necessary be in a bull market when compared to a hard currency such as gold."
. . . Dr. Marc Faber
We have read Dr. Faber's comments for years and have often found his insights to be net-worth changing. Fortunately, we agreed with his "buy the metals" advice of five years ago, which has befitted our clients immensely. Yet, the above quote from his recent missive is particularly to point. Indeed, bull and bear markets are extremely complex and an asset class that seems to be in a bull market may not necessarily be in a bull market when compared to another asset class. Furthermore, long-term investors need to measure their returns in "real" terms. For example, one dollar invested in the S&P 500 in 1926 compounds to $2,655 by the end of 2005. However, after removing the effects of inflation, taxes, and trading expenses that same dollar is worth just $46.59, according to a study by Thornburg Investment Management. Or how about this, as reprised in The Wall Street Journal (2/6/06), "If you have a house that you bought in 1970 for $100,000 and sold it for $400,000 today, the gain was just inflation – you made nothing. In fact, you may have lost money if you paid a 6% sales commission." Also adding insult to the inflation-injury has been the massive decline in the purchasing power of the dollar since 1970.
To this dollar demise, in past missives we have used the analogy of sitting on an airplane while additional passengers board. All of a sudden you get the feeling that the plane is moving forward. After a moment, however, you realize the plane next to you is backing out. Unfortunately, the same illusion can be applied to your stock portfolio. To wit, are prices going "up," or is the measuring stick (aka the dollar) going down? And, that is the question du jour investors should be considering. For example, the S&P 500 is "up" 5% in 2006. Yet, the "measuring stick" (a.k.a. the dollar) is down 5.9% since December 30, 2005 (basis the Dollar Index). Consequently, the foreign investor finds himself asking the question, "What rally?"
Regrettably, the U.S. dollar broke down again last week, which is surprising given the rise in U.S. interest rates that should actually buoy the "buck." Clearly, the dollar's long-term, and short-term, demise can be seen in the charts that follow this commentary.
Manifestly, we have been dollar "bears" for nearly five years. Over that timeframe the "greenback" has lost 32% of its value versus a basket of other currencies (read: The Dollar Index). Interestingly, if you owned the D-J Industrial Average (DJIA) over that same time the DJIA would have to be at 14784 just to maintain your dollar's value of five years ago (basis the Dollar Index). That is one of the reasons we suggested investing in some Canadian Dollar (Looney) yield instruments given our sense that the Looney was going to parity with the U.S. Dollar. When first opined, we received a plethora of negative comments stating that we were "nuts." Over the past five years, however, those comments have ceased concurrent with the "Looney's" nearly 50% rise against the U.S. Dollar. Indeed, where you stand is a function of where you sit. Unfortunately, we remain dollar "bears" and while in the near-term it is difficult to envision a crashing U.S. Dollar in a rising interest rate environment, longer-term the only way out of our debt situation that we can envision is for a lower dollar.
For those sharing these weaker dollar views, we reiterate our long-standing recommendation in non-currency hedged Aberdeen Asia Income Fund (FAX), which is selling at a 6.7% discount to its net asset value (NAV) and is yielding almost 7%. As well, we recommend Franklin Templeton: Hard Currency Fund (ICPHX). Other anti-dollar investments would be Rydex Euro Currency Trust (FXE), which represents ownership in 100 euros, and Citigroup Currency Linked Notes (CZJ) and Citigroup Global Markets (CAQ), both of which are pegged to different baskets of Asian currencies, excluding the Japanese yen. The two Citigroup Notes mature in 2008 and are scheduled to return a minimum of $10 a share even if the dollar does not decline versus the Asian currencies. As always, the terms and details on these types of investments should be checked before purchase.
As for the equity markets, while our Focus List continues to outperform the S&P 500 by 315 basis points (up 8.15% YTD), the investment environment, at least for us, remains difficult. That difficulty is being reflected in legendary investor Bill Miller's Value Trust (LMVTX), whose returns are negative year-to-date. As further evidence of this difficulty, last Wednesday the DJIA rose to a six-year high, yet NONE of the Dow's components tagged similar new highs. Additionally, despite all the huffing and puffing, the tech-heavy NASDAQ 100 (NDX) is 58 points below where it was on January 11, 2006! Meanwhile, the market leading Security Broker/Dealer Index (XBD) has broken below the rising trendline that has contained every decline since the mid-October 2005 "lows;" the Cumulative Tick Indicator is as overbought as it has been at previous upside inflection points; cash levels at the mutual funds are at extremely low levels, which historically has counseled for caution; a Hindenburg Omen signal has been flashed; complacency reigns; and as Lowry's notes, "Since Feb '06, each new high in the DJIA has been accompanied by a steady decline in the Buying Power Index and a persistent rise in the Selling Pressure Index, reflecting weakening investor Demand and an expanding Supply of stocks being distributed into the rallies. Similar patterns throughout our 73 year history have consistently led to significant market declines."
The call for this week: With everyone asking the same question (When will the Fed stop?), history suggests this is likely not the right question. What the right question is remains unknowable, but our guess is it centers around the dollar, housing, the consumer, and/or geopolitical events. Given the overbought nature of most asset classes, we are even rebalancing (read: sell partial positions) some of our "stuff stocks" since their recent rally has once again made them too big a bet in the portfolio. With some of that cash we have recommended taking a second tranche in the controversial stock of United Healthcare (UNH). The rest of the freed-up money from said rebalancing is resting in cash, which we continue to consider a viable asset class.
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