11-23-09

The Dollar Carry Trade

Sigh. I wish I could get wealth, power and fame simply by talking a good talk, like our good friend Obama. What must the Chinese have thought this week?? It's embarrassing. Sadly, I'm judged on RESULTS, not my oratory skills. So, until I get to be president, I'd better carry on actually doing something...

This 'Black Friday' will be very telling indeed. As you know, this is the day of the year when retailers finally get 'in the black', in other words, when they finally get into profit.

So let me get this straight. The average US retailer has to wait until the year is over before they actually make any money, and even then, it's in the hands of the gods?

How do they get out of bed in the morning??

If you're a retailer, please do explain (and I'll point you in the direction of a REAL business).

If you want to know a clever trick to spot cutting edge consumer trends, look to commercials that are out there from the smartest marketers. In a world of lies, especially from media and government, indirectly the most successful people in the private sector deliver us the truth.

Wal-Mart and State Farm are good examples and they're both tapping into what their marketing 'noses' smell as an environment of people cutting back both in terms of what they buy and how much they pay for it.

Now, we're supposed to be in a roaring V-shaped recovery are we not? Isn't that what the talking heads in media and government are saying??

I notice places like Target are getting aggressive for Black Friday with things like $3 toasters. Nice. But, if I already have a toaster, why would I care? Back in the good ol' days (you know, before October 2008) people would have bought a $3 toaster anyway, just for giggles. Now I'm not so sure.

Black Friday prediction: we will see reasonable revenues (which will get people celebrating), but on closer inspection profit margins will be down. From an accounting point of view, revenue is a relatively meaningless number; you can have a billion dollar revenue but only make a one dollar profit. Profit is what it's all about.

Or maybe people will finally vote with their feet and boycott the whole thing. This could be a nasty wake up call if they do...

But hey, that's the real world. Who cares about the real world on Wall Street?!

The party continues on Wall Street it seems. This week we had a technical stock market 'UP' prediction for the immediate future as the Dow Transports confirmed the Dow Jones recent high (see last week's letter). But, the market didn't want to follow through and ended up down for the week.

This is a market that is VERY uncertain of its footing and frankly, I'm wondering how valid traditional 'up' or 'down' signals are at this time. This may be because of direct market manipulation or it may be because of a lot of imbalances caused by all the government meddling.

As a loyal student of Dow Theory, I am forced to say this market SHOULD climb higher in the weeks ahead. But my gut doesn't like this prediction.

There are two types of stock market 'tea-leaf' reading; fundamental and technical. Fundamental deals with the sort of things I started this letter with; earnings projections, company assets, bigger picture issues about the economy (real world). Technical analysis deals with chart depictions of the actual stock market and what the market is doing.

I prefer to use technical analysis because the stock market more often than not does its own thing and this is the arena where money is made. Fundamental analysis makes predictions on what SHOULD be happening in the real world and supposes this should have an impact on the stock market (which is true but we can't say when the market will wake up to it). Longer term, fundamentals usually are correct. Shorter term, technicals are.

It's a broad opinion that the stock market is a sophisticated prediction of what's ahead. How can that be true though? If it was, why was the stock market flying high through 2007 and most of 2008 if it saw what was coming??

No, the market is simply a representation of the current SENTIMENT of all traders combined. Knowing this, we can deduce that these traders are, as a group, often WRONG. And this is where opportunity lies; in going against the crowd.

"C'mon Patricks, get with the party! Why don't you think this is a new bull market?"

Because never in history has a genuine, long-term bull market been born from stock VALUES as high as they were last March. It's that simple. We may have had an indication of a short-term blip higher, but this game isn't over yet.

The correction since March this year has been the steepest stock market recovery since the end of WWII. It's priced for a robust 5% GDP in 2010. P/E ratios (a classic valuation criteria) are now higher than they were even in 2007.

So the technicals say 'UP' but I can't see it as sustainable for very long with the fundamentals saying 'DOWN'. Bottom line: this is a traders market and if you want to play it, make sure you're ready to bail out and stay nimble.

There are also TWO major imbalances I find puzzling as they're flagging that all is not well and that things could be reversed any day. An imbalance means someone is very wrong... and the market likes to embarrass the most amount of people it can:

1. The bond market is still being priced as if deflationary headwinds are in our future. The bond market is larger and more sophisticated than the stock market. Bonds should move inversely to stocks and currently, bonds are as popular as stocks, if not more so. Somebody is wrong. The big money is still happy to be sitting in bonds. Why aren't they joining the party?

2. The US dollar is getting killed and most people believe this will only get worse. This takes some explaining...

This year, the US dollar has moved inversely to the stock market; as the stock market rises, the dollar goes down and vice versa. This suggests what is known as 'The Dollar Carry Trade' and has come about because of the Fed making borrowing rates so low. What happens is traders borrow dollars at low rates and buy higher yielding currencies from other countries that attract a higher interest rate and pocket the difference.

Simple, right? Yes, as long as the status quo continues. It used to be the Japanese Yen carry trade and traders learned the hard way then that the situation can change rapidly.

And here's the contradiction that bothers me...

Global trade is usually done in US dollars but as the global economy collapsed earlier this year and last, the need for these dollars decreased, so a sinking dollar is understandable. Ah, but aren't we supposed to be in a big, V-shaped recovery? And wouldn't that mean that the global demand for dollars would increase??

Someone is wrong.

The bond market can't get much more popular. The dollar can't get much more UNpopular. Obama and Geithner say they want a "strong dollar" (LOL). Who to believe?

Well, the bond market is perhaps artificially popular because banks are buying government bonds as part of an agreement with the Fed.

The currency market isn't subject to that- it's simply been going lower as stocks move higher. Everyone and their dog is short the dollar now.

The elastic band can only be pulled so far before it snaps back and the longer this imbalance goes on, the nastier the snap-back.

So, how might we (contrarians) profit from this longer-term?

You could buy the US Dollar against the Euro. You could short the bond market by buying an ETF called 'TBT'. Or maybe you'll just postpone that European holiday a little while longer.

To a League of Power member, likely events are not defined as negative or positive; all events are neutral. It's just a question of seeing how to profit from that event, and there's no sin in that.

Have a great Thanksgiving and cherish the family moments it brings. At this time, re-evaluate what's truly important to you because it can often be what or who we're most inclined to take for granted...

Happy Thanksgiving!

Mark Patricks

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