There is a saying that markets climb a wall of worry. That aptly describes the stock market’s behavior over the last few weeks. There isn’t a day that goes by without some talking head warning that “the markets are ahead of themselves” or “valuations are rich at these levels.” That may be true but investors continue to look over the valley and focus on what they perceive are the golden days of recovery ahead of us.
“I think we’re seeing the last big opportunity of my lifetime,” said a 62-year old investor from Canaan who lost 30% last year and is considering changing investment advisors.
He is disgruntled that his present financial advisor has missed most of the 54% move up in the Dow and still won’t commit to the markets. It is a common predicament for many in our business. Since last year many brokers and money managers lost between 35-50% of their client’s money, they are understandably cautious of a market that has gone straight up on extremely light volume. They worry that if they commit what remains of their clients money and guess wrong, they will be out of business.
The few mangers who called the market correctly last year, however, began moving back into the market in March and have been incrementally investing client money as the markets moved higher. I have to say that the last two years of market volatility has separated the truly good managers from what I call “Bull Market Babies”, those who are long on marketing but short on the unique ability of truly managing money.
On another subject, the plunging dollar continues to attract my attention. The dollar has made a new low for the year and I see nothing to prevent it from falling further. The dollar is normally considered to be a safe haven in times of uncertainty. The rise in the stock and bond markets on the heels of economic recovery has reduced the investor’s need to hide in dollar-denominated investments.
At the same time, the low level of U.S. interest rates (which the Federal Reserve promises will remain low for some time to come) makes higher yielding investments abroad that much more appealing. And there is also a growing perception that overseas markets, especially emerging markets, have already exited from recession and are quickly re-gaining economic momentum. As they do, their central banks will begin to raise rates in order to prevent overheating their economies, which can cause inflation. Higher rates cause their currencies to gain strength and therefore become more attractive to overseas investors.
Remember the carry trade of a year ago? I wrote a few columns on the probability that the practice of borrowing money in the Japanese yen (a low interest rate, cheap currency country) and then turning around and investing it in a country that offered higher interest rates and a stronger currency would unravel. It did, as the world financial system deteriorated. If the cheap dollar/low interest rate scenario continues to play out, we may see a resumption of that practice among aggressive institutions as the recovery takes hold worldwide.
I could come up with several additional scenarios. For example, speculators could borrow in dollars and then invest the proceeds into higher yielding Brazilian debt priced in their currency, called the Real, or in the Canadian dollar or wherever the economic prospects appear better than in our own struggling consumer-driven economy.
That would be a first in my career. It is hard for me to accept sometimes that the once-almighty U.S. dollar has fallen to such levels that speculators would consider that trade. It also makes me unhappy that countries are actively considering an alternative reserve currency in place of the greenback.
Traditionally, a country’s economic and political health is often-times reflected in a strong currency. However, some countries, like Japan and China for example, intentionally keep their currencies low in order to boost exports. In our case, the dollar has been declining for several years and genuinely reflects overseas investors’ mounting concern of our burgeoning government deficit, American’s low savings rate and our out of control spending. For years, many economists have warned us that such a combination would eventually hurt the dollar. Well, it looks like that day has arrived. I just hope it will turn out to be a temporary condition.