We’d like to pass on some comments on the dollar from Don Hays’s newsletter.  Yesterday, quoting research by GaveKal, Hays wrote this about the greenback:

• Fundamentals: The US current account deficit has been narrowing quite dramatically: at the end of 3Q09, it was -41% lower than in 3Q08. And as we have tried to show in our research, there is every likelihood that the US current account will reach balance within the next couple of years.
• Valuations: On Bloomberg’s CPI-based purchasing power parity measure, the US$ is -4% undervalued against the Yen, and -19% against the Euro. Against commodity currencies, the US$ is undervalued by more than -10% against the CAD, -17% against the Kiwi, and -21% against the AUD…
• Technicals: Momentum on the US Dollar Index (against six major currencies) turned positive late last year, with futures trading above the 50-day moving average. Of course, a Hays Advisory.com – Institutional Research February 18, 2010 - Page 7 of 9 key driver of this trend is the weakness of the Euro (see bottom chart on p. 2) but it is safe to say that the technicals are now very supportive of the US$.

This fits very well with HS Dent’s arguments for a stronger dollar in the months ahead.  Slower consumer spending means less demand for imported products — and a slimmer trade deficit!  Moreover, prices in Europe long ago reached absurd levels for holders of US dollars.  Given the euro’s own structural problems, this wasn’t going to last forever, and it finally appears to be correcting.

Charles Sizemore, CFA

With Greece in the headlines these days, there has been a lot of attention on Europe and the fate of the euro as a single currency.  As we’ve written several times over the past year (see prior posts), we believe that the euro is wildly over valued and that the fiscal position of the eurozone was only marginally better than that of the United States, if it is better at all.

The Financial Times posted a great graphic today that illustrates how bad things are across the Pond:

If you can’t see the graphic above, go to the Financial Times article.

The map shows current budget deficits.  Interestingly, the U.S. is in as bad of shape as Greece, Ireland, and the UK this budget year.  But looking at government debt as a percentage of GDP we see a different story.  Greece and Italy are basket cases.  Of course, Japan makes both look healthy, as hard to believe as that is.

Charles Sizemore, CFA

The Financial Times had a headline earlier this week that got surprisingly little attention: “European countries overtake top companies in debt risk league.”

As the FT explains it,

It now costs investors more to protect themselves against the combined risk of default of 15 developed European nations, including Germany, France and the UK, than for the collective risk of Europe’s top 125 investment grade companies, according to indices compiled by data provider Markit.

Markit’s iTraxx Europe index of 125 companies is trading at 63 basis points, or a cost of $63,000 to insure $10m of debt over five years. This compares with 71.5bp, or $71,500, for Markit’s SovX index of 15 European industrialised nations.

You could, perhaps, understand that an economic basket case like Greece would be a bigger default risk that a European giant like Royal Dutch Shell or Nestle.   But we’re not talking about Greece and the “PIIGS,” we’re talking about 15 of the richest and most advanced countries in the world–including Germany, France, and the UK!

Sovereign debt is, in theory, “risk free.”  So long as a country borrows in its own currency, it can never default; it could always print money to satisfy the claims.  Of course, in Europe this is complicated by the existence of the common currency and the European Central Bank.  European countries now are actually more like American states in that they have no currency of their own that they can inflate as a “safety valve.”  They can, again in theory, leave the eurozone, though this has never been done.  It remains to be seen how this would actually happen and what the effects would be on the euro.  (Our view is that it would create a major loss of confidence in the currency and cause it to substantially fall relative to the dollar and most other world currencies.)

All of this reinforces Harry Dent’s belief that in the years ahead sovereign governments will be at greater risk that top-quality companies.   This will be particularly true of much of Europe and of Japan.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

This post is a quick update to our ongoing commentary on the Greek fiscal crisis and its implications for the euro.  It appears that the European Central Bank is taking a hard line:

The European Central Bank has given its clearest warning to date that there will be no EU bail-out for Greece if it fails to control its spiralling deficit, raising the stakes in a game of brinkmanship over the future of the euro.
Jurgen Stark, the ECB’s chief economist and the powerful German member on the bank’s inner council, said Greece’s problems are entirely “home-made” and do not meet the terms required to trigger the rescue mechanism under EU treaty law, which is limited to countries that face severe difficulties “beyond their own control”.

“The Treaties set out a ‘no bail-out’ clause, and the rules will be respected. This is crucial for guaranteeing the future of a monetary union among sovereign states with national budgets. Markets are deluding themselves if they think that the other member states will at a certain point dip their hands into their wallets to save Greece,” Stark told the Italian daily Il Sole .

Source: Euro brinkmanship escalates as ECB shuts door on Greek bail-out

It will be interesting to watch this war of words escalate.  When it comes to the boiling point, we suspect that the European Central Bank will back down and come to Greece’s rescue.  But whether it does or doesn’t, we see the uncertainly surrounding the crisis weighing heavily on the euro in 2010.

Related posts: “Follow-up to “Who’s Next” — A Greek Tragedy“, “The Destruction of the Dollar? Not So Fast…“, “Follow-up to “Who’s Next” — Spain at Risk of Downgrade“, “Follow-up to ‘Who’s Next’“, “Who’s Next”

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

The currency markets and sovereign risk appear to be the media preoccupations du jour. Given that these are themes we’ve been following, we thought we’d pass these headlines on:

“Flaherty Says Russia, China May Buy Canada Dollars to Diversify”

Canada’s Finance Minister Jim Flaherty said China, with the world’s largest currency reserves of $2.3 trillion, may be poised to buy Canadian dollars as it seeks to shield its reserves against the U.S. dollar’s decline.

This would seem like a fine case of closing the barn door after the horse has already bolted.  Nothing against the Canadian dollar, of course.  In fact, Canada is a country that runs its financial affairs quite well by modern standards.  The loonie probably deserves room in a large currency portfolio.  It’s just that it’s a little late to be exiting the U.S. dollar after it has already been falling for ten years, and it’s unrealistic to expect the Canadian dollar to replace a significant exposure to American dollars.  The Canadian economy is roughly 1/10th the size of the U.S. economy, and the loonie simply isn’t big enough to be a major reserve currency. But then, if you expect worthwhile currency advice from BusinessWeek….

“Goldman’s O’Neill Says Spain May Hurt Euro Stability”

The euro’s stability could be jeopardized if the budget concerns hurting Greek bonds spread to larger economies such as Spain, said Goldman Sachs Group Inc. Chief Global Economist Jim O’Neill.

Yep.  We couldn’t agree more.  And neither can the currency markets, if recent activity is any clue.

“Fitch warns that Britain and France risk losing their AAA rating”

Highlighting the “unpleasant fiscal arithmetic” facing states across the Old World, Fitch said that none of the “arguably” benchmark AAA states can safely rely on their top rating for much longer.  Public debt in both Britain and France will reach 90pc of GDP by 2011, higher than the 80pc (net) level when Japan lost its AAA rating earlier this decade.

As if the bad news from “PIIGS” (Portugal, Ireland, Italy, Greece, and Spain) wasn’t bad enough, now the “adults” of Europe are also at risk of downgrades. Let us hope that they get their debts under some degree of control before they reach the level of Japan.  At this late stage, it is all but impossible to “fix” Japan’s debt problem.  We don’t know when or under what context, but we firmly believe that Japan will default on its debts in the years to come.  Default is the only way out when your debts are 200% of GDP and your population (and tax base) is shrinking every year.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

“The dollar traded near a three-month high against the euro on signs the global economic recovery is gaining traction,” we read on Bloomberg this morning.  Excuse us?  Let’s make sure we understand  this correctly; the world economy is improving, and so the dollar rose?

See, that’s odd because for the past nine months, the headlines have read some variation of “Dollar falls as risk appetites return and global economy recovers.”

So…an improving economy causes the dollar to fall until it causes it to rise.  That makes sense.

Nassim Nicholas Taleb, author of Fooled by Randomness, would have a field day with this.   (We’ve always considered Fooled to be quite a bit better than his more recent The Black Swan.)  Taleb dedicated quite a bit of the book to poking fun at the financial press, specifically their tendency to confuse correlation with causation.  In this case, the dollar is going up and the world economy is improving, therefore the dollar is going up because the world economy is improving.  This is not to say that financial journalists are stupid; far from it.  But the economics of the industry pressure them to “put the pieces together.”  Humans shy away from complexity.  They like absolute answers, not ambiguities.  And frankly, no one would buy a newspaper that read “the dollar rose (or fell) today, but it is most likely statistical noise with no significant meaning.”

Read the rest of this entry »

Continuing our discussion from the original post “Who’s Next?“, we see the Wall Street Journal beginning to sing our tune: “Tables Turn on the Euro”

The euro tumbled as debt woes spread around the euro zone from Greece, where pledges of austerity and fiscal rigor failed to stem growing fears that the Continent’s economic recovery could be derailed.

The euro fell as low as $1.4505 on Tuesday, its lowest level since early October. New worries about Austrian banking also roiled markets, with rumors of trouble at an Austrian lender with shaky investments in Eastern Europe following Monday’s surprise nationalization of another Austrian bank at the behest of the European Central Bank.

I was never much a fan of the “BRIC” concept.  For the life of me, I couldn’t figure out what Brazil, Russia, India, and China had in common that would justify grouping them together.  From what I could see, it was an acronym chosen for marketability reasons and nothing more.  Basically, it sounded cool.

Today, however, we have a new acronym that makes sense, the “PIIGS,” which consists of  the problem children of Europe — Portugal, Ireland, Italy, Greece and Spain.  Read the rest of this entry »

A funny thing happened on the way to the dollar’s imminent destruction: it broke its downtrend and is now looking to finish 2009 strongly. (See chart)

We’ve been highly skeptical of the “dollar bear” argument for quite a while now (see “Short the Euro“).  We wonder if half of the “experts” who joined the anti-dollar bandwagon over the past two years have ever left the United States.  Had they been to Europe recently, they would have found that prices there already defy reality for those of us paying in dollars. (My recent visit to Madrid was nearly 50% more expensive that the one I took a few years ago…and this during a period where Spain is suffering a severe deflationary recession in which domestic prices are falling.)

Long suffering readers of the HS Dent blog are probably aware that we are temporarily residing in Paijan, Peru (see “Unconventional Medical Tourism“).   Even here, in the coastal Peruvian farm country, about as far in middle of nowhere as you can imagine (see map), the dollar has lost significant purchasing power.  Prices are increasingly expressed in the local currency, the nuevo sol, and more and more locals are opting to be paid in soles rather than dollars.

Yet none of this makes sense.  Is the US federal government spending an irresponsibly large amount of money these days on stimulus…much of it borrowed?  Absolutely.  But so is virtually every European country, and yet the euro remains strong.  The same is true for the Fed’s excessively lax monetary policy.   As bad as it is, it is only marginally worse than that of most other developed countries.  As we wrote in a prior post (see “Who’s Next?“), some Eurozone members are at significant risk of sovereign default.  And what might a default by a member or, in the most extreme case, the exit from the Eurozone of a major regional economic power like Italy, mean for the future of the euro?  Let’s just say it wouldn’t be good.

The dollar was too expensive in 2000.  But today, after nearly ten years of grinding bear market,  the dollar is cheap and despised.  Legendary speculator George Soros is credited with saying that the secret to making money in the financial markets is to find the trend whose premise is false and then bet against it.  And we believe that the dollar bear market is one such trend.  And Soros’s old partner, legendary contrarian investor Jim Rogers, agrees (see “Jim Rogers is Loading Up on the Dollar“).

We remain bullish on the dollar for the next 6-18 months and recommend steering clear of the anti-dollar hysteria.

Related Posts:  “Gold is a Lousy Investment“, “Must the Dollar Fall If Stocks Rise?”

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

In a second follow-up to our prior post “Who’s Next?“, we now see that Spain is at risk for a ratings downgrade: “Spain’s Debt Woes Echo Europe’s Uneven Rebound”

This is a big deal.  Currently, the US dollar seems to be the primary worry among fretting investors.  And to be fair, the US fiscal position is horrid.  But the situation in Europe is potentially so much worse.  What would happen to the value of the euro or the stability of the Eurozone if a major country — say, Italy — were to leave the monetary union or get kicked out?  This is not idle conjecture; it is a real possibility.

Returning to Spain, the WSJ writes:

Spain became the latest euro-zone country to face a possible downgrade of its government debt, raising fears Wednesday that similar fiscal woes triggered this week in Greece are spreading.  The situation highlights the divergent paths that euro-zone countries are taking out of the most severe economic downturn since the 1930s. Ireland and a number of Southern European countries that outpaced larger nations during flush times are emerging from the crisis with their economies and finances in much worse shape than Germany and France.

This is not to say that things are rosy in Germany and France, of course.  But luckily, these two European giants did not lose their inhibitions in the mid-2000s wild bacchanalian debt orgy the way that much of Southern Europe did.  Furthermore, German and French demographics (though again, not good) are not nearly as bad as those of Spain, Italy, or Greece.   These three Southern European nations are facing a permanent loss of economic clout and possibly even their cultural identities due to plunging birthrates that guarantee significant population shrinkage in the years to come.

The fact that Spanish government debt yields only 0.7% more than German is puzzling to us given the risk that Spain represents.  But then, if Japan has managed to keep yields across its yield curve low even while the the country amassed the largest debts in the developed world, we suppose it’s not that shocking.  Government yields around the globe seem unreasonably low given the risk.  Investors, unfortunately, have few places to go for income these days.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

The New York Times ran a story that goes well with our post from Nov 30, “Who’s Next.” — “In Wake of Dubai, Trying to Predict the Next Blowup.”

Check out the graphic from the article:

Link to graphic.

Interestingly, while the United States does have significant exposure to the “at risk” countries such as Greece and Russia, it is the European Union that would be most damaged by a default.  European exposure dwarfs that of the United States, adding support to Harry Dent’s belief that the next major wave of debt crisis will originate in Europe (see July 2009 issue of the HS Dent Forecast).   This is something we intend to monitor in the months ahead.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy