Global Macro Roundtable
The following is an excerpt from our GMR #4 of 08 May.
Another relevant development in this debate is that of bond yields. The 10yr. bond yield is starting to make a "creep" higher and possibly signal that the US Dollar downtrend is bottoming. Sure, Fed officials say they don't care about the official USD rate but with major currency partners tightening their official interest rates this could push the USD even lower unless something gives way - likewise, stronger currencies abroad would crimp their recovering economies and they would start to complain about weaker export markets as their goods become more expensive to US consumers and companies. The effect of this is that the US equity markets might possibly be surprised :
"It keeps the Fed on hold longer when inflation is still a key concern", said George Goncalves, chief Treasury and agency strategist in New York at Morgan Stanley, one of the 21 primary government securities dealers that trade with the Fed. "We're looking for a steeper [rate] curve, mostly because of persistent inflation."
As can be seen in the graph below, the US Dollar has lost not only 30% in value over the 4-5 years, it is now dangerously close to long-term lows at the 80 level on the index. This would be a "major event" should the USD break down this key threshhold. One strike against the USD right now is the fact that money supply is increasing thus cheapening the currency even further - maybe the Fed really does not care about the currency on the world markets as long as it's national consumers are oblivious to the effects, like inflation due to higher import prices ; higher national debt ; etc. et.al.
Gold certainly has rebounded quickly from it's recent sell off even as the broad equity markets were rising - this is NOT normal behaviour but then again with "gold trading vehicles" now more diverse than ever, gold has broader access to receiving more of the investment dollars out there. It is nearly impossible to know how much is speculative and how much is strategic in terms of retaining purchasing power and/or central banks diversifying out of the USD into something more intrinsically valuable than simply "In God We Trust" paper bills - like gold or even the Euro.
With regard to investments, here is an interesting chart below (for this discussion disregard the neckline in blue - that was a study to show the effects of crossing below and above the neckline - powerful trends) : it shows the German DAX market growth (one of the strongest) verses the USD index (red underlay). Since mid-2003 there has been strong disconnect. As the DAX has increased net 150% since mid-2003 the USD has lost nearly 20%. Hence my rage when a number of US newsletter writers suggest that investing abroad can be "dangerous" due to currency risk. And what about the rest of the world investing in USD denominated equities and losing 20% of ANY gains due to reverse currency risks ! It is always best to invest in weak currencies and their markets which look fundamentally sound and set to rise against your home currency as opposed to investing in "strong" currencies looking set to weaken against your home currency. That has exactly been the case with US equity markets these last years. Had a US investor bought the EUR and the DAX since mid-2003 and stayed with it not only would there have been a strong equity profit but also a very nice cross-currency "bonus". Many professional US investors have long since been out of the US markets while yielding far better returns abroad, or at least overweighted in non-US equities.
That is why I now believe Japan has a relatively atrractive market - a bottom-forming currency in terms of USD and EUR and a fundamentally sound stock market. Certainly the JPY may have further to fall and I am not condoning jumping in with massive amounts of bets on the japanese currency or equity investment but rather our observations becomes a wee bit more microscopic in nature - we now look closer and more often. We might never catch the "currency bottom" perfectly, but the downside risk on the Jap. Yen looks reasonable when historically viewing the chart - not quite yet, but the JPY may see a cyclical upward movement yet my biggest worry remains the leveraged carry-trade and its implications for the markets. Here the latest from BMO on the Jap.Yen :
The yen weakened slightly vs. the greenback in April. It is becoming readily apparent that the BoJ won't be in a position to hike rates again until much later this year, with inflation likely remaining negative over the next couple of months as the central bank expected. Accordingly, the Bank cut its 2007 and 2008 core inflation forecast. With most other major currencies gaining ground vs. the US$, the yen performed very poorly on the crosses, falling to a record low against the euro, a near 15-year low vs. the pound, and a 10-year low vs. the A$.
After a blowout fourth quarter, first quarter economic data aren't as upbeat, with consumer spending still sluggish and business spending slowing. But the second quarter will likely see a bit of a bounce. The data should be increasingly upbeat as the year progresses, providing fodder for a late-year BoJ rate hike and, finally, some yen strength.
Stock market takes a well-earned breather; what's next?
A couple of weeks ago we talked about the possibility that the current earnings season would be another example of "internal rotation" for the broad market. This has been the dominant theme in almost every earnings season since 2005. What this means is that any negative earnings surprises would be taken out on a handful of stocks rather than on the market as a whole, allowing the benchmark S&P indices to remain above their nearby support and stay buoyant. And have they ever! The major indices are breaking out to record highs as we speak and there have been more positive than negative earnings surprises so far this season.
Recently I happened across something interesting in a report from a well known international investment bank. The institutional guys who write the firm's market letter (who incidentally have been cautiously skeptical since the February correction) threw out quite a few statistics hinting why the market's rise may not last much longer. They suggest that the current market environment has a "party atmosphere." I beg to differ, as we'll discuss a bit later in this newsletter. But they pointed out that since 2003, the DJIA has shown a roughly 12% annual performance. That compared with only a 7% yearly average rise in the DJIA since 1930!
We keep hearing from all quarters how the U.S. stock market is lagging the markets of the major foreign countries. That may be true, but a 12% annualized performance in the Dow is nothing to sneeze at. And the "lagging" performance of the U.S. versus the international stock markets since 2000 can probably be attributed to the "Rule of Alternation" since the U.S. outstripped everyone else in the 1990s. In other words, the rubber band has snapped back since 2000 so that for the past 6-7 years the overseas markets have outperformed ours.
Could this relationship be about to change once again? I believe it will. It was also pointed out recently by an overseas analyst that as the U.S. dollar has fallen by approximately the same amount that the S&P has risen in the last couple of years, essentially penalizing overseas investments into the U.S. stock market. Will the financial controllers allow this situation to continue unchecked much longer? The indicators suggest not. It was pointed out last week that with the 3-month T-Bill rate rising as strongly as it has since 2004 this generally precedes a reversal in the dollar trend. The dollar index is currently testing a major long-term benchmark low around the 80 level and this level should succeed in stopping the dollar from declining further against other major foreign currencies. The dollar will bottom and eventually stabilize and prevent major capital outflows from occurring.
The stock market itself is the ultimate prognosticator and barometer of the economy and it is telling us that things aren't nearly as bad as we're being told by the media. The recent semiconductor stock explosion is a huge "heads-up" signal that the bull market is still very much alive and well and will continue. It also tells us to prepare for the coming resurgence in the technology sector, a resurgence that will most likely include a nanotech boom and create a whole new "bubble" for the mainstream investor to chase. This will attract those foreign dollars faster than anything else and give the needed shot in the arm to the U.S. equities market and economy.
Another "heads up" leading indicator that reports of the U.S. consumer's demise were entirely premature was the huge rally in leading online retailer Amazon.com (AMZN) this week. Incredible is the only word that can describe the high-volume earnings breakout to a 30%+ gain in only a couple of days. Amazon is one of the five stocks in our U.S. consumer composite index that shows the true state of health in the consumer economy. Ebay (EBAY) is another one and it's currently just below its high for the year and shows a bullish looking weekly chart. The two trouble spots in this index are Fed-Ex (FDX) and Monster.com (MNST) but the breakout in Amazon is simply too big to be ignored. It strongly suggests that retailers will enjoy a resurgence in the coming months and I firmly believe the Fed's recent efforts at re-liquifying the economy will have the desired effects of lifting the consumer from his/her doldrums.
As we previously mentioned the Semiconductor Index (SOXX) had a big week this week and the rising semiconductor sector internal momentum (SOXMO) gave impetus to the recent rally. I've been asked to comment on the outlook for Intel (INTC) and I'll reserve that commentary for Monday's Stock Update. Suffice it for now to say that our trade in Cypress Semiconductor (CY, $23.08, originally recommended at $17) has been a major participant of semiconductor strength and traders should take some more profits right now as CY has rallied nearly straight up since the beginning of the month from approximately $19 to its current $23. Higher highs are anticipated further out, however, due to the recent earnings breakout in CY (see chart below).
Another reason to explain the recent strength -- and to expect the bull market to remain firm -- is the trend so far this year of money supply expanding at an ever-increasing rate. This is good news for the market and the economy and MZM growth has been stellar compared to the past two years of sub-par liquidity. The latest chart from the St. Louis Fed showing MZM growth on an annualized percentage change basis is almost breath taking. Check it out for yourself.
This shows the Fed's commitment to keeping the economy from sinking into recession per Alan Greenspan's prediction in late February. It also shows how the investment climate is becoming more favorable to growth-oriented companies. Speaking of growth, our growth stock ETF known as the Powershares Timeless Select ETF (PIV, $17.64) is doing well after the rocky period it experienced in late February to early March. Since the July-August 2006 bottom, when growth stocks finally bottomed out and began turning around, the PIV has marched right back to recover its previous high from last spring and a conservative upside object of $18.00 should be made before the next correction in PIV.
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Best regards from the GMR,