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.