Following The Trend

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Oct 24, 2009
The conception fuels the trend; however, the misconception is set to take effect. Therefore, all who are bearish on the US dollar are technically correct, although the bulk of the analysts are simply bowing down to the current downward trend. Most of the analysts were late to the party and will change direction on a whim depending on which direction the wind blows. Regardless of the fickle nature of the talking heads, the unfortunate reality is that the US Dollar is in a long term downtrend.

With reference to George Soros’ philosophy: First there is a trend, then there is the misconception of the trend, and the misconception of the trend fuels the trend and the misconception, which ultimately is unsustainable resulting in a reversal. In the case of the US Dollar, however, this time is quite different. First there is the trend, and then there is the sound fundamental analysis supporting the trend, and the sound fundamental analysis supporting the trend fuels the trend and the fundamental analysis. A true analysis of the US Dollar is what I formulated back in January 2007. The fact remains that the majority of these so-called “experts” are simply trend followers, blindly following the opinions of others, to the detriment of the participants who value their “expertise.” Once the Federal Reserve begins to raise rates you will see the dollar strengthen. The raising of rates and the strengthening of the dollar will become the new trend. The Dollar rally will cause the analysts who follow trends to give multiple reasons in support of the new trend, which will force the upward trend even higher. What we’ve seen, however, is that the Fed has lost the ability to create policy that is able to sustain its long term objectives.

The Fed cut rates from 5.75% in 2007 all the way to 0 in 2008. Initially, the analysts’ reactions to this move were consistent with the historical context, where rate cuts do in fact result in economic stimulus. This time, however, was quite different. We experienced the DOW reaching an all-time high one month after the Fed began to lower rates. Since that time the DOW has declined precipitously, to the point where the current rallies in the market are not based on Fed policy. Instead, these rallies have been based on misconceptions influencing the upward trend. One such rally was led by consumer sales, although consumer sales were led by the autos, which were influenced largely by “cash for clunkers.” Well, the “cash for clunkers” program is history, meaning that auto sales will no longer stimulate consumer sales, and as such there is no impetus to the next rally.

Another such rally was based on an increase in real property values over the year. Even still, Fannie Mae and Freddie Mac – government owned real estate giants – saw the value on their collateral decline by over $20 billion over the same period. Not to mention that under the Bush administration Fannie and Freddie’s budgets were increased to allow them to spend $900 billion a year. Well, that $900 billion/year is set to decline by 10% per year until it reaches $250 billion/year beginning at the end of 2009. Moreover, there are other factors regarding real property values which need to be considered before investing, namely (1) that the Bush administration invoked a moratorium on foreclosures that has expired this year; and (2) the Obama administration is issuing $8,000 in cash to homebuyers who have not purchased a home in three years, which may or may not be renewed after expiration on December 1, 2009. When taking into account all of the measures of government intervention aimed at preventing the freefall of real property values, I fail to see any efforts that create sustainable growth or which put real estate in a position to be the leading economic factor in a sustainable market rally.

Another rally in the markets was led by the Australian Central Bank (ACB). According to the ACB, Australia has climbed out of its recession. Australian exports to the United States are less than 5% of its economy; therefore, 95% of Australia’s income is derived from other nations. As such, Australia’s ability to bounce back has no correlation to a similar uptick in U.S. markets.

Another unfortunate reality is the rally in the U.S. markets represents a gain in nominal value, but not intrinsic value. The nominal value of US stocks is up about 30% in 2009. The US Dollar, however, has declined when held against the Canadian Dollar – down from a 52 week high of $1.30 to a low of $1.02 – and when compared to the Australian Dollar, against which it is down from a 52 week high of $2.03 to $1.31. Furthermore, when compared against the Euro, the U.S. Dollar is down from a 52 week high of $0.81 to a low of $0.66. This means that, while the DOW may have rallied about 30% on the year, our currency – the purchasing power behind the nominal values – has declined significantly. So what are the intrinsic values of the gains?

There are two points here: first, is that the Fed has proven incapable of stimulating the markets with rate cuts, and every other notable rally in the U.S. markets has been based on unsustainable government intervention or complete misconceptions about how the global economy really works; and secondly, is that the Fed has lost the ability to strengthen the U.S. Dollar, which sadly, has yet to be realized by most market analysts. Those participants who blindly follow the trend-following-analysts will get burned once the Fed is forced to raise rates. Ironically, those same analysts will convince those same market participants that the ensuing Dollar rally is solely a function of the Fed’s raising rates (again, referencing the historical context where the Fed can actually strengthen or weaken the Dollar by wielding rates). That rally in the Dollar will be as unsuccessful as the rally in the markets was when the Fed began to cut rates. Ultimately, we will be left with a misconception fueling the trend; however, when it reverses, the only questions will be, “how much will the Dollar decline, and how many participants will get burned along the way?”

Unfortunately, I fail to see how anything done with President Obama’s stimulus package will create sustainable growth. “Cash for clunkers” was indeed good for auto sales. As the $8,000 tax credits to homebuyers was indeed good for real property sales. Extending unemployment benefits is a noble idea. The infrastructure jobs are wonderful, until the work is complete. The bottom line is that none of these policies lend themselves to sustainable growth. The problem, as I see it, is that there is insufficient investment into sustainable growth, which leads me to the conclusion that once the stimulus money is exhausted, we will not just be back to where we started, but we will be even worse off because of the record deficits and runaway - inflation. As a student of history, finance and economics, I have never heard of a country having a weak economy and a strong currency. A country’s currency is only as good as its economy.

With economic instability and currency devaluation your investment strategy must have the weapon of gaining exposure to capital growth, without currency risk, political risk and poor corporate management.

Troy Holland

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www.TroyHolland.com