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Wednesday, September 3, 2008 - Vol. 10, No. 210
Today's comment is by Eric Roseman, Investment Director and editor of Commodity Trend Alert.
You can't really make a long-term bullish case for the buck right now. Sure, the dollar has had a strong rally recently, but that doesn't change the fundamentals. We're still looking at no interest rate hikes, a fiscal deficit that continues to grow, and weak consumption, thanks to an historic credit squeeze and real estate deflation.
And yet the buck has been getting a lot of love since early August - rallying nearly 8% against a basket of major currencies. What gives? Do global investors see positive factors we don't? Hardly. Overseas investors are simply taking advantage of cheap dollar-based assets and 2009 growth prospects for the U.S. economy that are more compelling than for other major economies.
In short, almost certainly, what we're looking at right now is not a new dollar bull market, but a cyclical bear market rally. That's exactly what happened in 2005 as the dollar rallied 12.8% versus the euro and other currencies. But back then the Fed was raising short-term interest rates and the U.S. economy was still firing on all cylinders.
It's quite a different story now.
In fact, the only thing that could keep the dollar rally going is a continued deterioration of other major economies while U.S. growth accelerates.
Bull Market or Bear Market Rally?
The dollar has gained against global currencies since August 8, when Germany's mighty economy contracted in the second quarter, triggering one of the biggest dollar rallies in years.
And maybe it was time for a rally. Since peaking more than six years ago versus the world's major currencies, the U.S. dollar has posted some dizzying declines. Only a few currencies in the world have actually declined in value against the sad buck since late 2001...one of which being the Zimbabwe dollar.
But this current bout of dollar strength has more to do with the surprising weakness of other foreign economies than a resumption of U.S. growth. We're simply ahead of the curve.
The market views the dollar as a leading currency as other economies begin to grapple with an economic slowdown or, in some cases, recession. The United States has already gone through the process of priming the economy with interest rate cuts and fiscal measures to boost consumption, driving the dollar lower in the process. Now it's the turn of the Europeans and Japanese. They are only now starting to enter slowdowns in their economic cycles.
That means they'll be cutting rates, so their currencies will weaken. And the value of their assets - in dollar terms - will decline.
Therefore, savvy investors in the next few months will look to build positions in some of the U.S. economy's most beaten-down, oversold assets. Specifically, foreign and U.S. investors alike can find significant value and opportunity in distressed U.S. debt, real estate and stocks.
Let's look at the debt first...
PIMCO Scoops Fannie and Freddie Debt
Some of the best values now lie in distressed mortgage-backed securities like Fannie Mae and Freddie Mac bonds. PIMCO, the world's largest bond fund manager with over US$800 billion in assets, has been aggressively accumulating the debt of both lenders.
Credit spreads for government mortgage agency debt have surged over the last few months and now trade at their highest levels in history compared to Treasury bonds. Premiums are now trading at just under 300 basis points or 3%.
The government has already guaranteed that both crisis-plagued mortgage lenders won't fail. That means Fannie and Freddie debt is cheap at current prices, even though shareholders are likely to get wiped-out if the government eventually nationalizes Fannie and Freddie.
And as the mortgage market goes, so goes the real estate market...
Buying Up Busted Properties
U.S. real estate also offers excellent values, particularly from rising foreclosures and bank repossessions. This is exactly what occurred in the 1989-1991 Savings & Loan crisis. Then several years later, vulture investors earned big profits from buying cheap properties.
In the most devastated real estate markets of Nevada, Arizona, California and Florida, investors can find an abundance of residential and even a growing universe of commercial properties gone bust.
To be sure, financing has grown more difficult for even the most creditworthy of borrowers as banks balk at lending. But many deals will be closed in the coming months and years, as banks grow increasingly desperate to get rid of a truckload of properties at fire-sale prices.
Real estate in the United States is extremely cheap when priced in euro, yen or most other currencies. In 2007, more than 20% of all residential property purchased in Manhattan was by Europeans. I expect that trend to accelerate in 2008, especially if the euro continues to soften.
U.S. Stocks Offer Some of the Best Values in Global Markets -
Especially when Accounting for Currency Changes!
Lastly, U.S. stocks offer big values compared to other markets because of the potential for higher currency-adjusted returns.
Over the last seven years, dollar-based investors have earned big profits in overseas stock markets, using the dollar's decline to rack up huge currency-adjusted gains in foreign stock prices. But the opposite might occur now similarly to the 1995-1999 period, when U.S. markets outperformed foreign markets.
Therefore, I expect U.S. stocks to finally benefit from a surge in foreign institutional money after years of net outflows. I also think the huge inflows into foreign equity funds will slow markedly over the next 12 months as mutual fund investors redirect capital to domestic funds, which have badly lagged behind other markets.
ERIC ROSEMAN, Investment Director
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