Gloom-god Roubini says that flooding the world with U.S. dollars at non-existent interest rates has let speculators push assets far higher than their “fundamental value” justifies. That may be true.
Then again, when have assets ever been perfectly aligned with so-called “fundamentals?” Hasn’t there always been a willingness to risk, reward, speculate and, hopefully, come out ahead? (Note: Markets can be “overvalued” for years… even an entire decade. In 1996, Greenspan described the overzealous stock market in terms of irrational exuberance. It took 4 more years for that bubble to burst.)
Roubini also says that the dollar cannot keep falling forever. This is a true statement, unless you believe the U.S. currency will collapse entirely.
Yet once again, the U.S. dollar is not likely to strengthen by bounds and leaps overnight. High unemployment keeps many from passing on prices to end consumers. Non-existent inflation data encourage U.S. leaders to support a weak dollar policy. And the Fed isn’t expected to raise interest rates until the middle of 2010.
Since it may take some time before the U.S. dollar gets legitimate suitors, the borrowing of U.S. dollars to invest in higher yielding and/or potentially higher appreciating assets is likely to continue for a while longer.
The biggest problem is the attempt to diversify away from the dollar carry trade risk. It can’t really be done. Everything that people worldwide are borrowing to invest in — bonds, currencies, commodities, stocks — will be liquidated to pay the loans back if the dollar charts a path towards strength.
The best defense, then? Keep an eye on PowerShares Dollar Bullish (UUP). If UUP climbs above 50-day and/or 200-day trendlines, you will assuredly need to raise some cash/take some profits.
When PowerShares Dollar Bullish (UUP) rose 0.76% on Monday, 10/26/09 (through 3:00 PM EST), a significant amount for a currency in a single day, assets across the board got creamed. Which assets got smacked down the hardest? Assuming the U.S. currency reclaims a chunk of its former glory in the distant future, could this type of activity be a predictor of downside risk?
|Best and Worst ETF Performers on 10/26/09 U.S. Dollar Rally (1 Hour Before Close)|
|Best||1 day %|
|Vanguard REIT Index (VNQ)||0.2%|
|SPDR Retail (XRT)||0.1%|
|iShares Goldman Software Index (IGM)||-0.1%|
|SPDR Gold Miners Index (GDX)||-4.2%|
|SPDR KBW Bank Index (KBE)||-3.9%|
|SPDR Materials (XLB)||-2.3%|
Full Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company may hold positions in the ETFs, mutual funds and/or index funds mentioned above.