Daily Dose of Optimism

Thomas Friedman

Thomas Friedman is paid $65,000 per lecture. Now, when I think of Thomas Friedman, I think of this interview.  If you're pressed for time, start around 1:45.

Volker on a Potential Floor on the USD

(Well, not a specific floor, but a conceptual one: the self-interest of strangers.)

Since the economy seems resistant to participate in our ongoing attempt at a 2003-replay, the primary driver I can see of continued growth in the market is weakness in the USD. Open question: is our Federal Reserve, and national government, willing to allow the USD to set new record lows (<72 vs world currencies) in order to "stabilize" the system? If not, what will be the signal to stop?

Currencies aren't necessarily all that different from stocks. Currencies are claims on the performance of a nation's economy and its assets. Currency value stems from investor desire to purchase items in that country, whether the items are financial assets (stocks, corporate bonds), real assets (manufactured goods, services, real estate, commodities),  or incentives for government assets (eg, high interest rates in gov't securities that can only be purchased with the currency).

Who are the shareholders of the USD? US citizens, and countries with foreign treasury reserves.

What does a conference call with investors in the USD sound like? No idea what they say behind closed doors, but the closest thing to a public transcript is probably comments from a G-20 summit. Unlike stocks, I don't think there is the concept of Reg FD; that is, if a foreign government tells the US government that the deficit is much too large, I don't think there is a requirement to share that with us retail holders in the general public at the same time.

We can mostly guess at the actual pressure being levied. Hopefully the private conversations are much more colorful than the public statements. A sample sign of what might be said behind closed doors is alluded to in this comment from Paul Volcker:

Reuters: Answering a question from the audience, Volcker said he doubted China would embark on a major reduction of its U.S. dollar-denominated assets, partly because the alternatives to the dollar, including the euro and the Japanese yen, do not look that great either. China has "a great interest in the stability of the dollar," he said.

Bloomberg has the audio.

2003 vs 2009

A question I have had a note to research for myself was how economic conditions underlying the current rally compare with those of the last successful recovery rally (2003). Fortunately, my reading of other blogs has provided me with some insight (saving me the time).

Via Zero Hedge, via Contrary Investor, the table below shows a comparison between prior rallies and the current one.

The data points that suggest things are better than we think are ISM and P/E ratio. P/E seems to indicate that things could still rally further, as we're not quite as overvalued as people might think. I believe ISM is partly affected by inventory restocking, which could be susceptible to business manager overoptimism, or a very early sign of recovery. The negatives on all other data points do raise some obvious questions.

The dollar weakness is not to be overlooked. If you care about the value of your assets in the context of all available purchasers in the world, then the currency adjusted stock market is relevant.

The question is, how much more can the US allow the USD to be devalued? A rise in interest rates from the Fed could put an end to this game pretty easily. What are they looking for?

I mentioned last week that 76 was a 1-year support level. The most recent gains have seen the USD index ease below that level.  Next significant support is at 72. Are we going all the way there?

Monday Inspiration

"Every man takes the limits of his field of vision for the limits of the world."

- Schopenhauer

(courtesy of philosophers at the MTA)

A Picture of Capitalism

From Whole Foods:

US Dollar Index - Prices & Charting via Bloomberg

For free intraday quotes on the US Dollar Index, see this page on Bloomberg.com. For the visually oriented, the website also offers graphs with intraday to multi-year data. Those who already have a Bloomberg terminal should be able to access this via DXY IND.

Small break today below 76, but unconvincing move in stock market; keep an eye on this to determine whether we're looking at a "melt up" scenario.

 

Related: I highly recommend the Bloomberg.com website as a source for financial news. Bloomberg has clearly been investing in the site over the past few years. It's nice to have many of the same articles that professional money managers have at their fingertips, even if there is a time delay before release to the web. Depending on what your day job is, the delay beats $1,800/month you would otherwise need to pay for access, which I believe is the current monthly retail price of a Bloomberg terminal.

While we're on the subject, the WSJ Mobile Reader for Blackberry is also fantastic.  I have generally found this to be one of the handiest and most addictive news sources ever. This app is a great example of how the news business can adapt to changes in the business/tech landscape.

Public Sector Unions & Healthcare

Under the brilliant leadership of Dennis Rivera, [SEIU 1199, an east-coast healthcare worker's union,] built a top-notch political operation, and with the hospitals, which were barred from political activity, formed a partnership to maximize the flow of government revenue. The union-hospital alliance has been so successful in aligning itself with politicians, Democrat and Republican alike, that not only has 1199 been largely untouched by the downturn, but New York spends as much on Medicaid as California and Texas combined. [...]

The justification for public sector unionism is way weaker than that for private sector unionism. "[Government] workers are not extracting a share of the profits but rather a share of taxes," as former N.Y. Liberal Party leader Alex Rose puts it. And the right to strike, in the hands of key public unions, approaches a blackmail power.

via Kausfiles

USD-Adjusted Wealth Creation in Current US Stock Rally

The market is witnessing a spectacular rally. This rally is occurring in an environment of a weakening dollar. If you didn't live in the US, you would need to factor currency into the value of your US stock holdings. This is not something Americans find the need to do; we're goldfish in a USD fish bowl. However, it is also possible we are forgetting to question assumptions about the significance of a weak dollar given that it hasn't weakened substantially until very recently. The USD index has ranged between 90 and 120  for most the data I have readily available (20+ years).

Taking a look at the SPY ETF (S&P 500, multiply by 10 to get index value): when you adjust the SPY for changes in the USD index, the recent rally is pretty feeble.

 

Notes: I skewed the right y-axis values so that the USD values could be read cleanly at the bottom of the graph. The SPY Global Basket is calculated daily as (SPY price) / (100 / (USD Index Price)). Starting value in Sept 1993 was (conveniently) 99.

Currency adjustments made using back-adjusted historical values for the US Dollar Index futures contract.

Wikipedia: The US Dollar Index was launched in 1973 by the New York Board of Trade (NYBOT). At its inception, the US Dollar Index was set at a base value of 100. The US Dollar Index includes the exchange rates of the following six currencies: euro (EUR), Japenese yen (JPY), Pound sterling (GBP), Canadian dollar (CAN), Swedish krona (SEK), and Swiss franc (CHF).

The stock market rally in 2003 and beyond looks like it was sustained by an environment of a weakening dollar. If this is a point of commonality with the current rally, the USD resistance levels noted in the prior post seem relevant for helping gauge whether rally will continue or falter.  A USD break below 76 seems like an invitation to more gains in US equities.

Allowing the dollar to weaken in 2003 was probably not a politically difficult decision, given that the USD was still quite strong against global currencies (~100). The situation is different when the dollar is at 76. The one obvious upside of a weak dollar at this point is the potential for increased exports, but I believe we aren't the only country in the world with that idea.

USD Carry Trade Deathwatch?

Question: does USD index hold resistance at 76, or are we headed back to test ~20+ year lows, set in late 2008? (71-72 level). Next few days should be interesting.

New Zealand Interest Rate Futures

The 15 year correlation between 90-day futures on New Zealand bank bills, and 3-year New Zealand Government bond ("stock") futures is 99.8%. Over the past few months, the spread between these futures prices widened by the largest amount in fifteen years. The 3-year future (blue line) lags the 90-day future (red line); the green line is the statistical significance of the difference.

Potential Causes: The strength in 90-day futures may reflect the strong rally in the New Zealand dollar. Carry trades that involve short-USD (central bank rate 0.25%), long-NZD (central bank rate 2.5%) may be overly invested in short-dated New Zealand instruments, pushing up the price relative to historical norms. Note that this relationship first started to break down in a significant way around April - May 2009.

Potential Trades: (1) pair trade; long 3-year NZ government bond futures, short 90-day NZ bank futures; expectation is that historical relationship will close. (2) The historically unusual activity of the 90-day contract may indicate that the current leg of the carry trade is overdone, evidenced by the breakdown in historical relationships between short-term NZ futures. In this case, short either contract, bias towards 90-day. (3) Null hypothesis; no trade.

Disclaimer: Please note disclaimers. This post (like all others) is a learning exercise for the author. Feedback welcome.

New Zealand Futures

New Zealand Dollar

NZD vs USD