The U.S. dollar - "King Dollar" - is kicking ass and taking names. Which is fine by us, as we've got a nice piece of the action.
The following was posted this morning in the Mercenary Live Feed:
06/20 Commentary: Dollar Rampage
8:21 am - June 20, 2013
The U.S. dollar went on an awesome rampage yesterday. Awesome, in part, because we caught a major piece of it…
Our thesis has long been that weakness in the USD was temporary - in large part driven by temporary unwinding of the yen carry trade. Basic fundamentals, plus confirming price action, put the USD in a long-term secular bull market after ten years of decline. This is the flipside of emerging markets imploding, which you also saw yesterday.
We felt that dollar / yen was going to rebound sharply at any moment… and we nailed it. Our exploratory short euro position - smaller because of the chart pattern, suitable for pyramiding later - also came through.
Why did the dollar respond so powerfully to the Federal Reserve testimony? In part, we believe, because a clearer picture is finally emerging. The U.S. economy is a juggernaut relative to dire Europe and weakening emerging markets. Asia is in a lot of trouble. Japan has already expressed the necessity of forcing a much weaker yen in order for Abenomics to work.
In addition to this, you have serious credit crunch problems developing in China - and for the first time in a long time, the real prospect of a China crash. Investors are seeing inflation problems sweep through emerging markets - note the huge protests in Brazil. All these factors are combining to fuel a massive repatriation of funds out of EM assets and back into home-based dollars, again strengthening the greenback.
The other crazy thing about Wednesday's action was the carnage in treasuries. The massive fall in treasury bonds had immediate and powerful impact on defensive yield plays. We articulated the "bearish sweet spot" for consumer staples (NYSEARCA:XLP) fairly recently. Yesterday we saw our chance to short XLP in major size.
And the beautiful thing is, these trends could be huge… with much more room to go…
As the great speculator George Soros once said, "I am good at riding the tide, but not the ripples of a swimming pool." Translation: Traders need big trends to make the truly big money. The return of the U.S. dollar - and the secular outperformance of the U.S. dollar vs. the rest of the world - is a HUGE, huge trend. HUGE.
Why has this possibility been so universally missed (or flat-out dismissed)?
Perhaps, in part, because a large contingent of the trading community is bottom-up focused - not overly concerned with sea-change macro factors.
And another large contingent of the trading community - call it the "Zero Hedge contingent" - has been myopically, religiously obsessed with the debt side of America's balance sheet, without properly considering 1) the ASSET side of America's balance sheet or 2) the positioning of the U.S. vis a vis the rest of the world.
Listen guys (and gals): In comparative terms, the United States is a juggernaut right now… an Arnold Schwarzenegger in a room full of 90 lb. meth addicts. Not only that, but the United States is rich… and I'm talking "richer than any other empire EVER" rich.
Correspondingly, every time I hear some goofball talk about how the U.S. government is "broke" I have to resist the urge to smack them upside the head.
I mean, just stop and ponder for a second. The United States is:
- an agrarian superpower (number one food exporter not counting multiple-country EU)
- a military superpower (who else controls two oceans?)
- a demographic superpower (look at our aging trends vs. Europe, Japan, China)
- a technology superpower [Google (NASDAQ:GOOG), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Intel (NASDAQ:INTC), IBM (NYSE:IBM), need I go on?]
- a soon to be energy superpower (we are about to start exporting oil again)
- the domicile of +$70 trillion in household wealth
- the home of the most desired real estate in the world
And the United States government has access to all of the above, in terms of assets to draw down on, by dint of our representative democracy.
In addition to all the above - as if that weren't enough - the United States is seeing genuine signs of recovery, albeit weak and slow. Now compare that to:
- Europe experiencing Great-Depression-like unemployment
- China's fiscal system on the verge of imploding (real estate market too)
- 70% of China soil contaminated / air, water pollution at crisis levels
- Massive infrastructure overcapacity, especially China but other EM also
- Japan in dire straits (hence the Abenomics hail Mary)
- Emerging markets in the grip of inflation (notice Brazil lately?)
Not only is the U.S. government not "broke" as some macro-illiterate doomers say, the USG has direct access (within a rule-of-law framework) to the most awesome pool of wealth, talent and natural resources ever assembled by one country in the history of mankind. Meanwhile, the rest of the world is almost literally turning to shit. Even the remaining countries with solid economic footing (Canada, Australia) are on the wrong side of the commodity bust with housing bubbles about to pop.
Now do you see why it's not just possible, but probable, for the U.S. dollar to commence an ass-kicking world tour?
Another way to wrap your head around the magnitude of what's happening is to read this excellent piece: The REAL Great Rotation by Richard Bernstein Advisors.
You really want to read the whole thing. But here is an excerpt:
…it remains startling to U.S. that investors still seem enamored with the emerging markets despite that EM stocks have underperformed U.S. stocks for more than five years, and that EM profit fundamentals continue to be among the weakest in the world (almost 60% of EM companies recently reported negative earnings surprises). The U.S. is even becoming a better growth story than the emerging markets. Smaller capitalization U.S. companies are projected to grow earnings 60% faster than are EM companies (35% versus 14% for the next twelve months).
In addition, many of the major emerging markets have serious monetary problems that make the U.S. situation look rather amateurish. India now has the highest inflation rate among emerging and developed markets and their central bank has actually been easing monetary policy. Brazil's President recently stated that stimulating growth was more important than was controlling inflation despite disturbing inflation trends and lack of productivity within Brazil. China's lending policies have been so out of control that the balance sheet of the People's Bank of China is now roughly 50% bigger than the Fed's…
And for more on deeper level fundamentals as to why the USD is back in a secular bull market - only paused temporarily by JPY carry trade unwinds - check out our call for a USD bottom more than a month ago.
Some other good news: A lasting resurgence in the U.S. Dollar Index (DXY) need not be bearish for U.S. equities.
For many years, as I'm sure you'll remember, the dollar was a key "risk off" indicator. When the dollar was up, equities tended to be down and vice versa. This was a function of heavy asset flows into Emerging Market (NYSEARCA:EEM) and multinational blue chips benefiting from emerging market revenues.
But now the situation has reversed. With U.S. domestic equities the new sweet spot for bullish positioning (see Bernstein argument), U.S. equities can rise even as dollar flows repatriate back home to the United States.
Think of this not just as a "great rotation" but a "great unwinding." For a long time EM debt and EM equities seemed the place to be. With the dollar strengthening and the rest of the world faltering relative to the United States, that is no longer the case. With every uptick in the greenback, EM assets look a little bit less attractive in relative currency terms (not to mention the problems they are facing - riots in the streets anyone?). The massive over-allocation to emerging markets in recent years is being unwound, as the whole "emerging markets century" idea is getting its license revoked.
[And by the way, a side note to Jim Rogers: I love you Jimmy, your book "Investment Biker" was my literal inspiration for getting into markets. But your uber-bullish China (NYSEARCA:FXI) call was about as long-term wrong as it is humanly possible to be. You are even more wrong on that call than the Dow 36,000 guys circa Y2K bubble. And as for permanent gold bugs? Oh man. If you thought your world of hurt was bad already…]
The correlation chart above, from Bespoke Investment Group, shows how the U.S. dollar / U.S. equities relationship has changed. The dollar and U.S. equities now have a positive correlation, rather than the negative one that persisted for years. This, again, is a function of the shifting relationship as outlined above (and in our earlier dollar piece).
I am short XLP, FXI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Also short EUR.USD, long USD.JPY