The main thrust of the past two months has been the renewed collapse of the U.S. dollar. The dollar has been on a one-way elevator ride to the ground floor since August, when U.S. Federal Reserve Chairman Ben S. Bernanke first warned that quantitative easing was on the horizon.
Most recently, the minutes of the Federal Open Market Committee's (FOMC) last meeting telegraphed further monetary stimulus. The minutes read:
In light of the considerable uncertainty about the current trajectory for the economy, some members saw merit in accumulating further information before reaching a decision about providing additional monetary stimulus. In addition, members wanted to consider further the most effective framework for calibrating and communicating any additional steps to provide such stimulus. Several members noted that unless the pace of economic recovery strengthened or underlying inflation moved back toward a level consistent with the Committee's mandate, they would consider it appropriate to take action soon.
Concerns about inflation being too low almost guarantees additional quantitative easing unless the recovery gets a big shot in the arm before the next meeting in early November.
Consumer price inflation was sluggish, at around 0.1% in September after logging 0.3% in August. Year-over-year, inflation is running 1.1%, down from 1.2% in August. This is super-low and means there is no threat to bonds at this time. It is also supportive of higher price/earnings multiples in stocks. The Fed is freaking out about this number, worried that it will decline into deflation.
Basically, the Fed thinks the economy is a mess and requires intensive care. And by the twisted logic of this season, the worse the economy is believed to be, the more people want to buy stocks because they think the Fed will make everything better by executing a well-planned policy.
I don't want to be too hard on the Fed - its leaders are only human. But the central bank's policy has clearly been erratic, and conventional wisdom has regularly been wrong about how its policy changes would affect the markets. So the issues of whether it is right to begin a new round of quantitative easing now, or what effect it will have, have plenty of room for debate.
The main dissenting voice among voting members is Thomas Hoenig, president of the Federal Reserve Bank of Kansas City. The minutes read:
Mr. Hoenig dissented, emphasizing that the economy was entering the second year of moderate recovery and that, while the zero interest rate policy and 'extended period' language were appropriate during the crisis and its immediate aftermath, they were no longer appropriate with the recovery under way...
In a speech on Friday, Fed chief Ben Bernanke appeared to downplay the size of the next Fed move on quantitative easing but also indicated that additional easing is likely. He went through a list of weaknesses in the economy, including unemployment "clearly too high" and inflation "too low."
Emerging Markets Eluding the Dollar's Doldrums
Federal Reserve policy - and the thrashing it's levied upon the dollar - is the main reason stocks experienced a late-summer, early-fall rebound. While it seems like a good thing that stocks are rising, the real danger is that if you cash in your new winnings you will find that you can buy a lot less with the money that you hold in your hands.
The truth of the matter is, though, that the dollar has been grinding lower since 2001. The downward trend has occasionally reversed higher, but based on Fed policy and global trading, the dollar has much further to fall.
That's why emerging market and commodity positions have performed well. The iShares MSCI Chile Fund (NYSE: ECH), iShares MSCI Thailand Index Fund (NYSE: THD), iShares MSCI Singapore Index Fund (NYSE: EWS), and Market Vectors Junior Gold Miners (NYSE: GDXJ) are among the biggest winners
These markets are up a lot, and they are still buzz-worthy. I still don't get the sense that this is an overly crowded trade. In past eras, out-performance by emerging markets has lasted years, not weeks. Keep in mind that this is not just an investment flows issue: This is where capital is being treated best at the moment, and that is why funds are headed there.
This point of view is best exemplified by the surprising action taken overnight by the monetary authorities of Singapore.
The Dollar Index, which measures the greenback against a basket of currencies, tumbled to a 10-month low on Friday, following Singapore's decision to tighten monetary policy and let its currency rise. That had the effect of lifting Asian stocks and copper to two-year peaks and gold to another record high. Singapore did this as a pre-emptive strike. Singapore essentially is trying to vaccinate itself against U.S. policy.
It's very courageous because Singapore is essentially saying that it is unafraid of competing with the United States and Europe in its select industries - pharmaceuticals, technology, finance and trade - and wanted to bulwark its economy against predations by the west.
This is the first time in nearly a decade that Singapore has taken such action, and while it might make the country's exports slightly more expensive in the near term, it should stifle the potential for inflation over time. It's kind of amazing, and completely different path than the one Asian countries took in 1997 when their economies and currencies collapsed.
For a comparison, look at Switzerland -- which has defended itself with a strong franc against the debasement of the euro last year and the dollar this year.
Value combined with growth and momentum, in short, is typically an unbeatable combination. For now that means regions like Turkey, Colombia, Thailand and India.