America's On Sale - and the World's Buying

The market action over the last week has been a mystery to many US investors. The negative data that would have caused triple digit declines in months past, no longer moves the market. Can you imagine how investors would have reacted to our current employment and retail numbers if this data had hit back in Q1? Even Freddy Krueger would have been spooked. Not any more. The tide has turned. While US investors are baffled by this market resiliency in the face of recession, foreign investors know exactly what's going on.

Last week our CEO met with a group of Italian investors who described a very dark economic landscape across the European continent. The weak dollar has taken its toll on overseas tourism. Italy, France, Spain, Germany and the UK cannot handle another slow travel season. Look for governments abroad to do all they can to decrease the value of their own currencies or else they will find themselves headed towards depression. The US would prefer that the dollar remain low as profits abroad offset weakness at home, but the Treasury knows it can only last for a season, and that season is about to end. With Europe's back against the wall, the currency landscape is about to change. The performance of our stock market since 'Bear Stearns Monday' is evidence that this trend has already begun.

We have grown accustomed to low domestic stock price valuations brought on by the weak dollar. Even as our economy experienced its latest boom, p/e ratios remained tame. The ten-year return on the S&P 500 sits at a meager 3.5% compared with 6.84% on the European 350 Index and 12.27% on the MSCI Emerging Markets Index. The only way to get decent multiples on our stocks is to have international demand. Why haven't we had international demand? It has had nothing to do with economic performance and everything to do with currency. Over the last five years, even if our Italian friends had made all the right US investment moves they still would have lost money because of exchange rates. Now it's different, they see that the dollar must rise out of necessity and US stock price valuations are dirt cheap. Foreign investment decisions just became very simple, buy US equities hand over fist and they will make it coming and going.

The green light for foreign domestic investment occurred on 'Bear Stearns Monday'. When the Fed took systematic financial failure off the table they reignited the rest of the world with confidence in our markets. Even the sleeping giant, China, is jumping on board. According to the April 8th BusinessWeek article by Liz Mak, 'The China Banking Regulatory Commission [CBRC] says it has signed a memorandum of understanding with the Securities & Exchange Commission in the US. The agreement is a de facto approval for Chinese banks and trusts to begin overseas investments in the US. It is similar to a previous understanding signed with the Hong Kong Securities & Futures Commission which allows Chinese banks to invest in equities, fixed income and mutual funds recognized by the US regulator.'

It's time to stop wondering how our markets can rise in the face of negative economic data or negative earnings reports. We've already experienced the 'mandatory' 25% sell-off that is typical of a recession and now we have cash pouring in from all over the world. Don't be naive to the influence of currency valuation on the stock market. Don't underestimate our ability to manipulate currency speculation either. Such speculation allows the US to control the destiny of the dollar in the futures market. A weak Europe is not in our best interest, the dollar needs to rise, and it will.

This is all very bullish for US equities and bearish for foreign markets. Building short positions on ETFs like FEZ, EZU, IEV, or PEH is a great way to hedge your US investments. The prediction of tomorrow's strong dollar is causing a major relocation of world-wide assets today. Mystery solved! America's on sale and the world is buying.

Disclosure: None

Comments

[bowlmar]

Um, the volume for the markets has been waaaaaayyyy down the last month. I don't see a massive flow of money here. I'd chalk it up to the Working Group, aka Plunge Protection Team, putting in a bottom. CNBC openly talks about it now, to "calm" investors. The fix is in - SP bottom is set at 1270, and DJ bottom is set at 11600.

[Malkiel]

I noticed some of the back-channel commentary two years ago mentioning that US markets actually have a lack of product (available shares from public companies) in comparison with the demand (private pension vehicles and foreign investors). At that time the issue was share buybacks, which seem to be on hold for now (but why? The discounts are outstanding today). It would seem that the recovery, whenever it comes, is structured to be a roaring bull market grab for the shrinking pool of equity shares in US companies...

[buyitcheap]

The dollar is cheap and will get cheaper as we print our way out of this problem. We're going to be stagnant for a several years at least.
The end game though rates must rise, asset prices deflated, and so the dollar will strengthen UNLESS, dollar denominated hard assets (oil) do a "giselle" and get repriced in euros or the coming gulf currency. The reduction in demand for dollars are disturbing - Long FXF.

[MattBlackman]

Your assumptions all hinge on the US and the rest of the world going into recession... You say that the average sell-off in a recession is 25%. OK, except that the NBER still has to confirm we are in recession and typically, stock market corrections continue after a recession has been confirmed.

Oh and one more thing.. priced in gold, the Dow Jones Industrial Average has fallen 73% since peaking in 1999...

[MattBlackman]

Correction - your assumptions hinge on the US and the rest of the world NOT going into recession....

[crowdofcheerleaders]

the real story is not stocks/bonds/securitie... the real story is how much of our infrastructure are we going to outright sell to foreign interests. i'm talking interstate systems (toll roads), rail, etc. that is what's going to be interesting, as well as citizens' reactions to it.

[DrTSPC]

Interesting article. Is there a way to determine/find the fraction of transactions that are made by foreign buyers?

[keo]

You really should back this up with numbers. How many transactions are done by foreigners in 'normal times' and how many are done now ? You are really satisfied too quickly by your "explanations&quo... This is one of the worse articles I haved read in times on seekingalpha.

[User 170687]

Markets aren't moving south because Bergabe gave the I-banks $30B to trade with, it has nothing to do with foreign buyers.

[DrTSPC]

I am interested in seeing some data on foreign investment, and I have not been able to locate. It makes sense; i.e., US markets have been well into a bear market price range in many important currencies - well before recent fed actions. (The recent Fed actions actions may affect such investments through the predicted future value of the $.)

[chrism1962]

I think that the performance of the US stock market has more to do with the inherent bias of investment firms to being long, then FDI flows.

As an example of poor analysis ( or too bullish views), ask the following:

Out of 16 Analysts, for GE, 10 were BUY, 3 were Overweight and 3 were Neutral, no wonder the market reacted so badly. Why did no Wall St analyst take their financial exposure into consideration?

All of the institutions that have analysts appear to refrain from rating their peers at anything below neutral, even during a financial crisis. Is this Wall Streets final defense, or just the ineptness of its analysts?

For the worst case of being long look at Thornburg Mortgage (TMA).

Under the rescue package $1.3 Billion is being injected, and the Equity guys will receive $2.75 Billion of Warrants (that cost 1c each, $27.5 Million).

The price of TMA is currently $1.25 each, so these shrewd Equity guts will do the following:

Upon the dilution, they will short the stock, and be happy with $1 per share. Total return $ 2.75 Billion, Total profit on share sale $1.45 Billion. On top of this they will have the loan of $1.3 Billion ( totally secure against ALL of the TMA mortgage book) with a yearly interest of 12%.

Now TMA does have a good name, but effectively that is all that it has, so the common shareholders have been diluted to practically nothing, the execs keep their highly paid jobs, and nobody (except for the common shareholders) will lose, whatever the outcome.

As long as the stock price is held at ridiculous levels, shorting the stock on dilution, will become a brutal spectator sport, and the poor common stock holders, will be hammered. So please, any of the little guys out there, sell NOW, before dilution, as after dilution, and the short selling, I expect the price to drop to well below 50c.

(Chris Marshall)

[karchad]

This article is right on the money as far as its conclusions. All I can say is, if you're "wondering how our markets can rise in the face of negative economic data or negative earnings reports", then you have no stock market experience. It happens all the time. 1982, 1991, 2002 all blared negative headlines while the market moved up sharply. It will be no different this time. If you're a long term investor, now is the time to buy, not when all the headlines are good, by then the market will be up 50%.... I earned great money in 1991, then in 2003, and I'll do it again. The rest can buy gold after its 4x runup.

[WAKEUP]

This article reads like the first draft of a paper for an Economics 101 class. Example: "Don't underestimate our ability to manipulate currency speculation either. Such speculation allows the US to control the destiny of the dollar in the futures market. A weak Europe is not in our best interest, the dollar needs to rise, and it will." - - - Please. - - -I hear more authoritative discourse than this, from the kid who delivers my newspaper.

[What do Iknow?]

I have to agree with Wakeup. This article is way below SA's usual standards. Who is this author? It does read like a college term paper.

[finmah]

Europe is going to get crushed if they don't debase - no question.

Why all the gold shills seems to tout the party line that highly valued currencies are critical to survival - really then why do the export countries for the last ten years attempt to debase routinely? What has Japan economy done with their beautiful currency or the Swiss - not lighting the world on fire.

Look at each nation's growth that is high- either export manufacturing with cheap currency- Asia, India or countries that are not being hampered like we are by 30 years of antigrowth green peace movements. These countries export their natural resources - Canada, Aus,Brazil,Norway, and Russia nice currency rise against ours. The tide will change soon as indicated when the commodity run even just levels and the dollar has no where but up as mentioned.

It would be nice if we seasoned as an electorate and allowed natural resources to be a bigger part of our economy similar to the highly touted "environmentally sensitive" elite countries listed above that are in a drilling,mining,blasti... mania.