The third question of the week was about the U.S. dollar. Long-time readers of these epistles will recall my turning negative on the greenback, as well as bullish on “stuff” (energy, metals, agriculture, cement, timber, etc.), in the fourth quarter of 2001. In the 4Q07, while still remaining friendly towards stuff (albeit much more cautiously), I recommended shutting down ALL those anti-dollar “bets” with the Dollar Index around 75. Since then, I have been neutral on the Buck.
Last week, however, the Dollar Index decisively broke out to the upside in the charts and no longer looks neutral. Instead, it looks like the first leg of a new bull market. Bettering its March 2009 reaction high of ~90 would confirm a new bull market in the U.S. Dollar Index. Regrettably, the dollar’s strength could pose near-term problems for commodities and our beloved “stuff stocks.” Nevertheless, I like tangibles over the longer term because of rising demand from the emerging/frontier countries—and due to my unshakable belief that higher inflation will eventually surface.
The Sovereign Debt Question, From Charles Biderman, CO TrimTabs Investment Research
The sovereign debt crisis spun out of control in the past week, and we see no easy way to resolve it. Governments in most developed countries—not just Greece, Portugal and Spain—are grappling with aging populations, huge debt loads, high taxes and uncompetitive labor markets. Many of these governments have no realistic way to repay their debts except by printing money. We suspect it will take a lot of time and a lot of pain for the sovereign debt crisis to be resolved. We also think the rally from March 2009 through April 2010 was not the start of a secular bull market but merely a temporary spike amid a longer-term decline, much like the rallies in the early 1930s. Our key indicators give us further cause to move to the sidelines:
1. The U.S. economy is recovering only gradually. Adjusting for tax changes, income tax withholdings rose 4.5% y-o-y in the past two weeks, slightly higher than the 4.1% y-o-y growth in the past three months. While we estimate that the economy added 262,000 jobs in April, several temporary factors that have been boosting the economy—including census hiring, government stimulus programs and tax refunds—will be fading or ending soon. We are surprised the economy is not performing better because the U.S. government is spending $125 billion per month more than it receives in revenue in this fiscal year. To put this amount into perspective, it is equal to one-quarter of the roughly $500 billion per month in after-tax income earned by all U.S. taxpayers.
2. Our corporate liquidity indicators are mixed. On the buy side, new stock buybacks have averaged a solid $1.5 billion daily in earnings season, but only $8.9 billion was used to buy U.S. public companies in the past month. On the sell side, new offerings rose to a three-week high of $4.4 billion in the past week despite the sell-off, and insider selling has climbed to the highest level since January 2008.
3. Our demand-side indicators have turned a bit less bullish. The TrimTabs Demand Index, which aggregates 21 flow and sentiment indicators, was 84.9 on Thursday, May 6, almost seven points below the interim high of 91.8 on Monday, April 5. It is particularly worrisome that investors are piling into U.S. equity ETFs, which received $6.2 billion (1.3% of assets) on the past 12 trading days. Equity ETF flows are one of the best contrary indicators in our flow data.
Random Noise, From Stephen J. Huxley, Ph.D., chief investment strategist, Asset Dedication
The Dow’s intraday market somersault on 5/6/10 saw it drop nearly 1,000 points before rallying back to a loss of “only” about 347 points (-3.20%) for the day. One rumor is that an online trader had hit the “b” key on his computer for billion instead of the “m” key for million while selling Proctor and Gamble shares. When the order entered the system, it triggered a trading cascade because P&G is one of the companies in the Dow. When the Dow fell, it triggered even more sell orders on automatic trading systems, and down went the Dow.
If the rumor turns out to be true, this would represent the sort of random event that creates what researchers refer to as random noise in the overall trend. It may take awhile for the memory to fade that markets can move abruptly and severely. And the fact that the system did not flag such a large trade for scrutiny has already, as expected, led to talk of an investigation.
This incident offers the opportunity for some perspectives on market movements. The worst one-day percentage drop in market history occurred on Oct. 19, 1987 (-23%). How would someone feel who had bought in on the day before?
Pretty bad, obviously. But more important, where would they be 10 years later if they stayed invested in spite of the drop? Turns out they would have earned slightly better than 13% per year because they would have captured much of the Great Bull run of the 1990’s. Had they stayed out of the market, they would have suffered a severe case of seller’s remorse.
Barber and Odean (2000) showed how individual investors trying to time the market gave up significant long-term returns compared to those who stayed the course and stayed invested through turbulent markets. This week’s turbulence is yet another reminder that the ability to predict random events continues to elude even the most seasoned analysts. Thus the key to clients’ long-term success is to help them find an asset allocation they understand and can stick to so they don’t sell into the noise and trade away long-term returns.