by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
October 19, 2009
Key points
- Questions abound about the dollar and gold as inflation signals … we see something else.
- We believe momentum-chasing is the primary driver of a lot of what's working in the markets.
- There are numerous investment implications of these trends—we discuss those for both equities and fixed income.
Liz Ann talks about gold and the dollar
 Strange Brew … What the Dollar and Gold Are Telling Us
Recorded October 19, 2009
A month or two ago, I promised I would pen a report that would answerthe most-asked questions I've been getting at client events and throughother channels.
Interestingly, they have a dominant theme: all tied to the weakness inthe dollar, the strength in gold, rising government debt—and what theyall say (or don't say) about inflation. Today's report dives into thesesubjects again. It's longer than usual, so bear with us.
Oil no longer to be priced in US dollars?
The heightened media attention on the dollar's 14-month low (against abasket of six major currencies) is a key culprit behind the rash ofquestions we've been getting.
There's no greater example of a story that has captured investors'attention than the one in a British newspaper that claimed Arab oilsheiks were conspiring with Russia and China to cease using the dollarto set the value of oil.
It was immediately denied by everyone ostensibly involved, from thehead of the Saudi central bank to US, Chinese and Russian officials.
In fact, the story seemed odd from the get-go in that it was onlyvaguely sourced, included only one quote from an unnamed source, anddidn't name any officials who had allegedly participated in the secretmeetings. It also didn't mention anything about the meeting's locationor date(s).
The only "detail" in the story was the year 2018, which was alleged tobe the year by which oil would no longer be denominated in US dollars.It was ultimately discovered that the author has historically beenassociated with very radical theories, which has served to squash thecredibility of the story, at least for now.
The problem, of course, is that the dollar's downward momentum was onlyexacerbated by the rumor and serves to highlight not only the globalmood of concern about America's currency, but also today's era offast-moving information flow and loads of money-chasing momentum (thereal culprit behind the dollar's weakness and gold's strength in ouropinion).
This new downside momentum for the dollar comes on the heels of aperiod from late last year into early this year when the dollarbenefitted greatly from a flight to the relative safety of USTreasuries and other dollar assets.
In the heat of the crisis, the dollar was seen as less risky than otherinvestments. But we believe the key to renewed weakness is the massiveebbing of global risk aversion since the crisis' heyday.
The bottom line: The risk calculus has reversed and nondollarinvestments have been much more rewarding while holding the dollar hasbecome a performance drag.
"Dollar strength is in our best interest" is rhetorical
The weak dollar is seen as a virtue to some—and it's assumed that's theview of the Obama administration and its Treasury Department.
The current administration (and the two that preceded it) publiclysuggests it favors a strong dollar, but all indications are that it'swilling to quietly tolerate its fall, if not cheer it.
The pro-dollar weakness case rests on the aid it provides to USexports, the trade deficit and related manufacturing job growth. Itcould also help achieve the long-sought rebalancing of the globaleconomy—with the United States exporting more and others (notablyChina) importing more.
Unless the dollar's weakness turns into a confidence-shattering crash(oft-predicted but not a view we hold), it's likely the key playerswill continue down this quiet path of tolerance.
Dollar weakness: good now, bad later?
Regardless of the short-term benefits that accrue from a weaker dollar,we mustn't forget the perils of a weak currency in the long-term.
Chuck and I both mentioned this at the recent Talk to Chuck Town Hall,referencing an op-ed in The Wall Street Journal by economist DavidMalpass—someone I know and for whom I have great respect.
His argument is that capital flows dwarf trade flows as a source ofwealth creation. The only way to build wealth and create morehigh-paying jobs over time is through the productivity gains that comefrom greater investment and innovation.
As the dollar falls and capital flees the United States for othercountries, those global competitors reap its benefits and become moreproductive and relatively more prosperous. That is the most significantproblem a weaker dollar brings in the long-term.
We share these concerns, as well as those about our burgeoning public sector deficit. Historyshows we can run lofty deficits for some time before the cart tips. Butthe markets' and investors' tolerance won't last forever.
If the bond market specifically, and investors generally, see acredible deficit-reduction plan that's aided by strong economic growth,a dollar crisis can likely be avoided. However, without that plan, thedoomsayers could be proven right.
Shorter-term, we come down on the side of the debate that the recent weakening of the dollar is a sign that markets are normalizing after the flight-to-safety trade that dominated the crisis period.
The dollar has also found a new role as the funding currency in the"carry trade," whereby investors borrow in low-rate dollars,subsequently selling them to invest in higher-return investmentselsewhere. It appears to have overtaken the Japanese yen's prior rolein this trade.
As long as the dollar's secular (longer-term) decline remains containedand steady, there are positive aspects to a path toward multiplereserve currencies versus the dollar as the sole monetary standard.
The role of the dollar as the dominant international currency drove theUnited States' large trade and current account deficits, which haveonly recently begun to improve.
In fact, the huge related inflows of foreign capital turned out to be aprimary cause of the recent financial crisis as they contributed to lowinterest rates, loose monetary policy and excessive liquidity (not tomention the role of questionable regulatory oversight). These conspiredto cause investors to ramp up leverage and vastly under-price risk …and we know where that led us.
Indeed, a sudden halt by our creditors to support our debt (unlikely,as it would be aiming the gun squarely at their own economic feet)would weaken the dollar further, push rates and inflation higher, andweaken the economy yet again. But a sudden halt is not in the cards.
According to the International Monetary Fund (IMF), today, about 65% ofthe world's reserves are in dollars and about 25% are in euros. In theearly part of this decade, the dollar represented more than 70% whilethe euro was less than 20%.
There is a diversification shift under way and it has accelerated recently, but it's generally occurring slowly. Ultimately,it's a proper shift: A global monetary system that rests on a singlecountry's currency is not ideal. We have started down that path.
China's not going anywhere for now
For those who fear a Chinese retreat from the dollar, note that thecountry has actually increased its dollar holdings—buying up moredollars (and more Treasury bonds), thus preventing its currency fromrising and so keeping its export industries humming even in the face ofthe weakened US economy.
This might change, but a crisis is unlikely until China becomes lessdependent on its exports to the United States. It will likely play outover a period of years (not months), and will depend on both economicand cultural changes that will allow their savings-obsessed consumersto become greater global consumers.
We know it's equally problematic if foreign investors do finance ourdebt for an extended period. This might be why there's growingtolerance for a less prominent role for the US dollar in the globaleconomy.
Many now believe that the huge capital flows that necessarily accompanydeficits and currency dominance might no longer be in our country'sbest interest. This is the view of Fred Bergsten, former assistantsecretary of the Treasury for International Affairs, and it's gatheringadherents. (Read Bergsten's "The Dollar and the Deficits: HowWashington Can Prevent the Next Crisis" article for more.)
Inflation bogeyman not as scary as he looks
There's a growing concern about a major inflationary threat posed byour burgeoning deficit, very easy monetary accommodation, and theweakening dollar—further highlighted by the sharp rally in the price ofgold.
We remain in the camp that there's no imminent price inflation risk onthe horizon, largely thanks to the pressure that remains on wages andunit labor costs (due to weak labor demand), a historically lowcapacity utilization rate, diminutive lending by financialinstitutions, and benign market-based indications of inflation risk.Treasury Inflation-Protected Securities (TIPS) are telling us inflationwill be under 2% for the next 10 years.
Many folks with whom I've spoken assume that the budding economicrecovery is also inherently inflationary. This is not the case , as thechart below shows. Historically, inflation tends to fall for a fullyear after recessions have ended.
Inflation generally falls as economy recovers
Click to enlarge
Core CPI is based on year-over-year percent change. Source: FactSet and the US Department of Labor as of October 19, 2009.
Another sign that inflation risk is low, presently, is the velocity ofmoney argument—one we've used a lot to express our views.
Indeed, money creation has surged during the past year, but there areno signs of inflation … meaning a lot of this excess money is going toshore up banks' capital bases and/or fuel asset price inflation (gold,stocks, etc.).
Velocity of money is also referred to as the money multiplier, which Iexplained in detail in an earlier report this year on inflation vs.deflation. Mathematically, the money multiplier equals M2 money supplydivided by the monetary base. Generically, it's the amount of moneygetting from the banking system into the economy.
Until the velocity of money begins to accelerate, inflation is unlikely.
Monetary base up dramatically, but velocity of money remains impaired
Click to enlarge
Source: FactSet and the Federal Reserve as of October 9, 2009.
We can keep putting gas in the tank, but if there's a leak in thebottom, it won't help the car run. Our bottom line remains thatinflation is not a near-term risk, although it remains a longer-termconcern if deficits aren't reined in.
But what about gold's dramatic ascent?
Finally, many are pointing to gold trading at more than $1,057 an ounce as a harbinger of inflation.
Gold bulls abound! (Where were they all four years ago when gold washalf its current price?) In contrast to conventional wisdom, gold is adubious indicator of inflation. Historically, gold prices have risen inboth inflationary and deflationary periods as highlighted in a recentreport by BCA Research.
The first gold bull market was in the mid-1930s, when gold was revalued upward by 70%. This was a highly deflationary period.
The second gold bull market started in 1971, when the dollar wasde-pegged to gold, causing gold prices to soar. This was aninflationary period.
The third gold bull market started in 2001 and has so far lasted fornine years. During this period, the world economy has been confrontedwith periodic deflation threats, first with the tech bubble bust andmore recently with the financial crisis and attending recession.
The only factor that can consistently explain gold price moves is thespeed of fiat money creation. Dollar-based liquidity, a measure ofglobal money creation, has had a strong influence on the direction ofgold prices since the 1980s. As BCA notes, if money creation cannotlift general inflation, excess money must find its way to assetmarkets, lifting asset prices. Bingo.
Recently, gold has represented a proxy for risk. If you're jumping onthe gold bandwagon, be mindful of the possibility that gold could turnnegative once (if?) the world economy has rebounded strongly andcentral banks are ready to tighten monetary policy.
Investment implications
Schwab Sector Views highlights
by Brad Sorensen
As an investor, one way to benefit from the secular decline in thedollar is to make sure you have a sufficient allocation tointernational markets.
One way you can do this is by investing in US companies and sectorswith high levels of international revenues, such as the technology (50%of the S& 500 technology sector's revenues come from internationalsources), materials, industrials and energy sectors.
We currently have an outperform rating on the technology, materials and industrials sectors.
The energy sector has a marketperform rating due to its inconsistentposition of high-elevated levels of inventories relative to the valueof crude oil.
Although we don't recommend investors apply the math below to theirallocations given higher volatility and lower liquidity associated withmany international equity markets, the change during the past fiveyears in US equity market dominance is compelling.
| Country | 2004 equity market cap | 2009 equity market cap | | United States | 51.3% | 41.7% | | Europe | 28.8% | 29.1% | | Asia/Pacific | 15.2% | 20.8% | | The Americas (excluding the United States) | 3.7% | 7.1% | | Africa/the Middle East | 1% | 1.3% |
Source: Bloomberg as of October 8, 2009.
See the Read more box at top right for the complete Schwab Sector Views.
Fixed income highlights
by Rob Williams
There are a few options that should provide some protection against a falling dollar:
- Consider allocating a portion of bond portfolios to unhedgedinternational bonds—up to 15% of the fixed income portfolio—based onyour specific allocation targets and risk tolerance. Use a mutual fundor exchange-traded fund (ETF).
- Adding unhedged international bonds does insert the added variableof currency risk. But, if you believe the dollar will continue to fall,this might be what you're looking for in a part of your bond portfolio.
- Adding an emerging market bond fund or ETF can add dollardiversification, as well, but beware: Credit risks (and volatility infund prices) can be high. Limit higher-risk investments, likeemerging-market bonds and high-yield funds, to 20% of your bondportfolio (combined) for the most aggressive investor.
If you are more concerned that interest rates will rise:
- Shorten maturities in your bond portfolio by choosing short- orintermediate-term bond funds. Limit your exposure to longer-term bondsor funds.
- You'll be better-positioned to reinvest at higher rates if interestrates rise with shorter maturities (fewer than five years).
- You'll balance the risk of falling prices in longer-term bonds withslightly higher yields with intermediate-term maturities (five to 10years on average), or an intermediate-term bond fund.
If you're most concerned about inflation:
- Allocate up to one-third of your bond portfolio (maximum) toinflation-protected bonds, including TIPS. Your income will be lower,but TIPS should provide protection of principal if inflation risesfaster than markets expect today.
- The best protection against rising inflation is likely to be stock investments, which grow as prices rise.
See the Read more box at top right for the complete bond views.
Conclusion
Like the rebound in global stock markets, the adjustment to massiveglobal monetary stimulus has been quick and sharp, but maintaining thisrate of change is likely unsustainable. It's likely that the stockmarket and the dollar take a breather at some point (with stockscorrecting and the dollar finding a bid).
The move in the dollar in particular has taken on momentum-typecharacteristics and is a "crowded trade," with overwhelmingly bearishsentiment (a contrarian indicator). As we saw with crude oil in 2008(and as we warned then), these types of moves tend to overshoot andthen reset.
Factors that could provide a short-term countertrend lift to the dollar include:
- Moves by foreign governments to weaken their currencies in an effort to boost their own exports.
- Any change in expectations for Federal Reserve policy that wouldimply a sooner-than-expected rate hike (something about which we'vebeen warning).
- Any change in posturing by the Obama administration with regard to dollar policy could give a boost to the currency.
There has been a dramatic rise in the amount of capital moving inthe world—all of it in search of the highest returns. The dollar, gold,equities (domestic and emerging market), and US Treasuries are allpartaking of the same surge in global liquidity.
Investors of every ilk have a tendency to focus on short-term gainsover long-term discipline. And, of course, information flow isinstantaneous today, fueling not only a herd mentality, butestablishing the preconditions for the era of bubbles in which wereside presently. Beware of the herd. |
发表于 2009-10-23 17:02:53
楼主