Welcome To The Paradigm Shift

Includes: DIA, SPY
by: Mycroft Friedrich

The second quarter showed the first signs that the United States' economy is finally standing on its own two feet for the first time since 2007 and Federal Reserve Chairman Bernanke in his latest press conference clearly pointed out that the Federal Reserve Board expects the unemployment rate will drop down to 6 % by 2014, that inflation will be around 1.5% and that we should have a stronger GDP growth rate going forward.

The world is experiencing what is called a "Paradigm Shift" right now and for those who don't know what a paradigm shift is here is the definition:

Fundamental change in an individual's or a society's view of how things work in the world.

This shift that the world is experiencing is the fundamental change in the policy of the Federal Reserve as they will eventually reduce (or Taper) their bond purchasing program going forward. With the U.S. economy obviously improving, home sales booming, purchasing managers indices improving and with consumer confidence at a 5 year high the years 2014-2018 should be very good for the economy here in the USA, but probably not so good in the rest of the world. The reason for this is because the U.S. dollar, which has been treated like the illegitimate stepchild over the last 13 years, should now reverse its course and start to go up over the next decade. Therefore, U.S. multi-nationals like IBM (NYSE:IBM), Apple (AAPL) and Procter & Gamble (NYSE:PG) should suffer going forward as they will have to deal with the rising dollar, which will make their products overseas more expensive. A consumer in the United Kingdom will think twice when they go to buy some Kellogg's (K) Frosted Flakes for example, after they see the price has gone up 20% due to the strong dollar. Multi-nationals like Coca-Cola (NYSE:KO) and Pepsi (NYSE:PEP) have had a free ride for the last 13 years as the dollar went from 114 in 2000 to 74 in 2011 (35% drop) and will now have to deal with the exact opposite situation. Since that low, it is now trading at 83.41 for a 12.7% rise from the bottom and with the tapering coming up by the Federal Reserve, we should see that trend continue.

Bonds, which have had their prices artificially inflated due to the Federal Reserve's buying are in a world of pain right now as they are now falling from their all-time highs. This selling is causing all kinds of problems throughout the world and as investors sell bonds. Investors ignorantly plowed $112 billion into U.S. Bonds from January to May and then Mr. Bernanke woke up the choir on May 22nd and since that day investors have pulled a record $61.7 billion from bond mutual funds and exchange traded funds, according to TrimTabs. The outflow, which surpassed the previous record of $41.8 billion at the height of the financial crisis in October 2008, is a sharp reversal of the recent trend. Then add the sell orders from institutions and you have a seriously ugly bond party on your hands and thus we have the makings of a serious paradigm shift starting.

So as you can see the rate of selling in the Bond market is 50% higher than it was at the beginning of the financial crisis of 2008, so this clearly shows that a panic is definitely present in that market. But the strong dollar is also an enemy to the commodities markets as most everything is priced in dollars. Gold and silver as a result have fallen through the floor and are selling at close to their production values. So watch out for those miners as they are pretty much running with negative free cash flow numbers right now.

Therefore I believe

1. the U.S. dollar will go up over the coming years.

2. Multi-nationals' earnings will be flat to down going forward.

3. Gold and Silver along with other commodities will continue being pummeled as emerging market growth is slowing down.

What is an investor to do?

The answer is just do the opposite and buy companies that will benefit from the strong U.S. dollar and those are the ones that generate more than 75% of their sales in the USA.

1. The U.S. economy is improving so their sales should go up as consumer confidence should improve dramatically.

2. Their profits should improve as they are buying their raw materials to make their products at greatly reduced prices.

3. They will also have the advantage over foreign competitors as importers will have to raise their prices while American firms will have the ability to drop their prices in order to compete.

So avoiding multi-nationals and buying domestic operators should be a win-win. Such a strategy should also outperform the markets over the next five years as 45% of the S&P 500 Index is made up of multi-nationals, It's even worse for the Dow Jones Industrials Index as 21 of the 30 companies that make up that index are multi-nationals or 70% of that index. Therefore both the S&P 500 and DJIA Indices will have the wind against them going forward, As interest rates start to rise companies like Ford (NYSE:F) and General Motors (GM) will suffer as they have had massive sales numbers recently, as new car interest rates were recently the lowest ever, but are now back to 2.7%. When that number hits 3%+ car buyers will start to consider keeping their old car for another year or two and thus companies like Genuine Parts (NYSE:GPC) will do well.

So the new paradigm shift is here and as the U.S. dollar gets stronger and yields rise then as a result:

1. The party for emerging markets is over.

2. The party for the S&P 500 & DJIA and NYSE Index investors is over.

3. the party for bonds and commodities are over.

4. The party for multi-nationals is over.

5. The party for utilities, REITS and MLPs is over.

In the meantime, the party for domestic holdings will just be starting on July 8th when earnings season begins. Finally dividend investors are going to get a wake up call as interest rates start to rise because utilities, REITS, master limited partnerships usually pay out much more in dividends than they generate in profits and thus have to borrow money to pay out their dividends. So their profits will go down as they need to borrow more money at much higher rates to pay out their dividends, but even worse as rates go up they will need to raise their dividends in order to compete with higher yielding bonds. As people start dumping their bonds, they will eventually end up buying domestic plays like Patterson Companies (NASDAQ:PDCO) and Henry Schein (NASDAQ:HSIC), which are pretty much a duopoly in the dental industry.

Disclosure: I am long PDCO, GPC, HSIC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.