If the goal of Ben Bernanke’s Jackson Hole speech and the recent FOMC statement was to weaken the dollar, well mission accomplished. Since Bernanke laid out the Fed’s options for creating more inflation on August 27th, the US dollar index has dropped 5% and all manner of risky assets have moved higher when measured in dollar denominated prices. The S&P 500 is up 9.7%, the DJ-AIG commodity index nearly 8% and gold, despite a lot of attention, is lagging the field at up just about 5%. Some other individual commodities have done better with sugar up nearly 30% and the agriculture sub index up a mere 13.5%. And while US stocks have surely risen as the dollar has fallen, dollar based investors in foreign markets get an extra boost from the falling dollar. The EAFE index is up 11.7%, emerging markets are up 11.3% and Asia ex-Japan, where many countries are tied more directly to the dollar, up over 15%.
It is one thing for the Fed to debase the dollar and raise the dollar price of assets and it is entirely another thing to create real growth so don’t let the money illusion fool you. There is a reason the Fed has spent the last four decades trying to convince everyone it would keep inflation in check; there are consequences for inflation that may not be evident in the short run but will be all too apparent when the bill comes due. The rising price of commodities - or more accurately, the falling dollar - is not something we should be cheering since it just means capital will be diverted from investment in productive assets. The Fed has monopoly control over the supply of US dollars but they have almost no control over how they get spent. Right now, at a time when we desperately need capital investment, dollars are instead flowing into the ground.
The economic data last week was anything but cheery but in the perverse ways of the market, that turned out to be a good thing for stock prices. The worse the growth data the more likely it is that the Fed will turn to some of those unconventional policies Bernanke outlined in Jackson Hole. And make no mistake, it is growth the Fed is concentrating on right now. In their Phillips curve world view there can be no inflation right now because there is so much “slack” in the economy. They see the CPI and other measures of inflation rising at 1% year over year and think we are on the verge of deflation. I look at gold, copper and a long list of other commodities and wonder if the Fed has access to a Bloomberg terminal and a history book. By the time the Fed’s inflation shows up in the CPI, it will be too late and the damage will be done.
The Fed is getting the blame (credit?) right now for the weak dollar but just as culpable are the politicians and the Treasury Department. Chuck Schumer (D, Smoot) and Sander Levin (D, Hawley) may believe they are telling the world they want a stronger Yuan by threatening tariffs but what the market hears is that they and other politicians want a weaker dollar. Tim Geithner and President Obama push China to revalue the Yuan higher in the belief that a lower value for the dollar will help our balance of trade. Unfortunately for them, commodities are priced in dollars too and a weaker dollar means higher costs for US companies. Besides, if weakening the dollar is the answer to our trade deficit why do we still have a deficit with Japan? We had a deficit when the Yen was 300 to the dollar and we have a deficit now at 85 to the dollar.
With all branches of the US government now pursuing policies to weaken the dollar and increase inflation, it would be foolish to bet against them accomplishing their goal. With monetary policy focused on increasing the supply of dollars, Congress focused on policies that discourage investment and the President focused on blaming others for our homegrown problems (Calm down my Democratic readers; Bush and Paulson were just as wrong to blame the Chinese), the dollar is about as well loved as LeBron James in Cleveland. Increased supply and reduced demand have a predictable outcome.
As I said above, the economic data last week was not exactly robust. The Goldman and Redbook retail reports both weakened even with what Redbook described as a “very promotional” back to school season. Housing starts did rise in August but the annual rate of 598k is still way below the long term average just over 1 million. Furthermore, most of the gain was in multifamily up 32.2%; foreclosure victims have to live somewhere too. And permits are running even slower than starts at 569k. At best I think you can say the housing market is stabilizing at low levels.
Existing and new home sales confirmed the trend or rather the lack thereof. Existing sales were up 7.6% but prices fell and inventory remains high at 11.6 months. New home sales were also up but at 288k the rate of sales is still very weak. Supply is absolutely low at 206k but at this rate is still too high to keep prices from falling - again. Mortgage applications didn’t provide any hope with both purchase and refi applications falling. The refi boom might be over. I don’t want to get too negative on the housing market with the Fed pursuing inflation and the Treasury pushing a cheaper dollar but it is hard to see an end to this mess anytime soon. On the other hand, history tells us that a weak dollar means higher real asset prices and real estate certainly qualifies. I would also note that homebuilder stocks are actually acting pretty good right now.
The Leading Indicators ticked higher by 0.3% in August but the biggest positive contributor was money supply. Consumer sentiment also moved the index higher but the gain in August appears to have been reversed in September so that doesn’t seem likely to last. Jobless claims continue to frustrate rising 12000 to 465k. I’ve been looking for some hope in the non seasonally adjusted numbers but those were up even more last week. The jobs picture is not improving.
The most encouraging report of the week was the durable goods report. The headline showed a drop of 1.3% but ex transportation were up 2%. Most categories outside aircraft were up on the month and most importantly capital goods orders rebounded significantly. Non defense capital goods orders excluding aircraft were up a healthy 4.1% and shipments were up 1.6%. As I’ve said many times, the economy will improve when investment improves so this is good news. The weak dollar policy of the Fed and Treasury are a major headwind to investment and that might account for the volatile nature of the current uptrend in orders.
As I said at the beginning, the markets had another up week with US stocks up roughly 2% on the week. Foreign markets continue to outperform and assuming the dollar continues to weaken, I see no reason to think that is about to change. I do wonder though if emerging markets might be getting a little too much love right now. It seems I can’t turn on tout TV without hearing someone tell me about the virtues of economies once thought too risky for the average Joe. That many of these analysts have a better chance of finding Turkey on their plate than a map should probably factor into your investment decision. Europe might offer some bargains and a tad less volatility than some of the more adventuresome choices.
As I’ve been saying for some time now though, I think the best opportunities are to be found in real assets. A falling dollar is a tailwind for commodities and real estate. The commodity indexes have not recovered nearly as much as the stock indexes and are technically breaking out right now. REITs, despite all the bad headlines about commercial real estate, have outperformed stocks by a wide margin this year. Foreign Real Estate ETFs may offer the greatest upside as US investors will benefit from the weaker dollar more directly.
Sentiment on stocks is still too bullish for my taste by the way. The rally since the beginning of September seems to have awakened some animal spirits or at least some risk taking spirits. Whether this is a function of Fed policy or in anticipation of the election results in early November, I fear that optimism about either is misplaced. Fed policy can reduce the value of the dollar and create inflation but it can’t produce real growth. At best it produces what the Austrian economists call malinvestment. What’s that? Well, all those houses that are on the market and falling in price? That is malinvestment in spades and about the last thing we need right now is to waste more capital doing more of what got us here in the first place.
The same could be said of electing Republicans to Congress by the way. Until we get a political party that understands the importance of the dollar, it won’t matter much which party is in charge. The current debate about extending the Bush tax rates is instructive. Democrats blame the Bush tax cuts for every economic problem they can think of and Republicans seem to think if they just ignore the results everyone else will too. Both sides act as if the tax rates were changed in a vacuum. Well, the fact is that monetary policy - and specifically the weak dollar policy of both the Bush and Obama administrations - overwhelms any effect from the change in tax rates. Yes, raising taxes will hurt growth at the margin but a weak dollar will undermine any benefit the economy might gain from retaining the Bush rates. So, unless the Republican party has suddenly discovered the benefits of sound money, turning Congress over to them won’t do much good. Any rally based on a change in control of Congress is suspect.
Disclosure: Long: efa,gsg,djp,fxy,rwx,iyr,icf,ifas,ycs,vxx