For this week’s main message I’ll touch on the all-important (critical even) dynamics around the dollar, then I’ll cut and paste some key highlights from our latest messaging…
Fiscal spending at historic levels… Fed balance sheet bloated beyond recognition… Running interest rates at zero (“for the next 3 years”, despite the promise of a growing economy)… Fed to allow the economy to “run hot” (read inflation) going forward … $3 trillion++ of additional stimulus coming… $2 trillion savings overhang… Reopening… yada yada…
All of the above and, not to mention, ~$15 trillion of U.S. dollar-denominated debt held by foreign corporations means that the dollar virtually has to stay weak — as debt holders must convert their home currencies to dollars to service that debt… My the global currency crises that could develop should the dollar itself be allowed to “run hot”…
Now, one can argue — and many in fact do — that with all that foreign debt having to be serviced/repaid in dollars, with the U.S. economy receiving so much fiscal support, with U.S. interest rates high on a globally-relative basis… well… all that spells a constant bid for the dollar.
And, to add fuel to that fire, if indeed the dollar accelerates to the upside, there’ll be a mad dash (essentially short-covering) to pay down that foreign-owned dollar-denominated debt… Pushing the dollar ever-higher in the process!
But here’s the thing, when indeed the dollar spiked last spring, the Fed dove in and extended 14 currency swap lines with foreign central banks to stem the tide.
Here’s from Reuters on 3/19/2020:
“Dollars have been in huge demand – and tight supply – in markets outside U.S. borders as banks, companies and governments scramble to secure them to service the dollar-denominated debts many have accumulated. That has sent dollar-funding costs spiraling and has led to a historic run-up in the dollar’s value against other currencies. The dollar index =USD has gained more than 7% in eight sessions, a run not seen since the early 1990s. Several of the currencies targeted by the new swap lines saw immediate relief from the Fed’s action.”
And my how it worked!
I red-circled the date of the Reuters article on the dollar index graph below (which captures the first half of last year):
Bottom line: Like we’ve been preaching ad nauseam for well over a year, the current global setup simply cannot do a sustainably rising dollar, nor notably higher interest rates for that matter.
Our core portfolio is positioned well in light of this long-term reality…
Highlights from recent blog posts:
A conversation with a friend yesterday prompted me to pull the following from Jack Schwager’s enlightening interview with hedge fund manager Colm O’shea: emphasis mine…
“…you shouldn’t expect a big bull market to end in any rational fashion.
The smart managers will be managing less because they don’t look as good as the bulls, since they’re going to have lower net long exposure?
Right. Because the bulls control most of the money, you should expect the transition to a bear market to be quite slow, but then for the move to be enormous when the turn does happen.
Then the bulls will say, “This makes no sense. This was unforeseeable.” Well, it clearly wasn’t unforeseeable.”
“How then did you position yourself during 2006 and 2007?
We recognized that we would underperform the bulls by quite a bit because in a bubble the true believers will always win.
That’s fine. You just need to make decent returns and wait until the market turns. Then you can make great returns.
What I believe in is compounding and not losing money.”
“…our U.S. equity exposure is tilted toward materials and industrials, as well as toward the areas that will be the direct beneficiaries of tax incentives (13% of our target U.S. exposure is divided among the producers of solar energy, wind energy, lithium, rare earth minerals, uranium and water) — while the rest of corporate America has tax increases to look forward to. The latter will be touched on today as well.
As for direct exposure to related commodities, we’re capturing the industrial metals via DBB, and silver, individually, via SLV.”
“Biden’s set to talk up infrastructure spending like we’ve never seen tomorrow afternoon. If he’s convincing, it could play nicely for our materials, metals, etc., exposures…
But, thing is, if he’s convincing, we could see rates even higher in response.
Man, this has to be playing on the nerves of all those folks who thought growth stocks would continue to rocket to the moon!
Well, they certainly might resume their march into the stratosphere (especially if/when the Fed steps onto the long end of the treasury yield curve), but this isn’t the best technical setup I’ve ever seen:
QQQ (Nasdaq 100 tracking ETF):
The shorts (green line) are certainly piling on to QQQ:
As are the futures speculators who trade the underlying index:
Of course this could backfire on the bears if some bullish news sends growth stocks higher — leaving them to cover those positions, and, once again, exacerbate the upside…”
“A friend recommended Annie Duke’s Thinking in Bets over the weekend. I had already read it, and, yes, it’s definitely worth recommending. In fact, I’ve quoted her a few times herein.
Here’s from a December of last year blog post. It speaks volumes about the danger of confusing all positive short-term results with quality decision making. I suspect that Archegos was doing just fine with all of those levered positions — thus thinking they were good decisions — until they weren’t:
“In a nutshell, Annie Duke captures what I view to be probably the greatest, albeit hidden, danger that more than any other explains how too many folks ultimately fail at the game (the art) of investing.
It’s the too-often destructive (eventually) — at times devastating — belief that short-term positive results always stem from quality decision-making:
“…as I found out from my own experiences in poker, resulting is a routine thinking pattern that bedevils all of us. Drawing an overly tight relationship between results and decision quality affects our decisions every day, potentially with far-reaching, catastrophic consequences.”””
“PCE (the Fed’s preferred inflation metric), came in below expectations — fueling the fire for those who think that folks, like yours truly, who see inflation as a real threat going forward, simply don’t understand output gaps, labor market slack, etc.
Well, we/I do, but we/I also recognize that monster fiscal injections into the economy will continue going forward, against everything from production bottlenecks (that are slow to cure), protectionism, on-shoring (Intel announced new production facilities coming to Arizona [ya think maybe chips will be a bit more costly to produce there than, say, in Chengdu?]), and so on.
All the while the central bank under no circumstances will allow interest rates to rise enough to quell the pressure, as would occur in a true free market.
So far, by the way, the market agrees with us/me:2, 5 and 10-year breakevens (inflation expectations reflected in the yield spread between inflation-protected and nominal treasuries) continue to rise, notably:
“We humans simply can’t help it; we’re either drawn to what we want, or to what we fear. And it’s not entirely innate. Our surroundings — what we watch, whom we listen to, our past experiences, and so on — can indeed influence our bias toward fear or greed at any given moment…
As portfolio managers to many of you readers, we here at PWA have to do everything humanly possible to remain open-minded to any and all possibilities. Which is why we must constantly, and painstakingly, crunch the data, study and chart the history, measure the thickness of the ice, take the outside temperature and, when it’s all said and done (which of course it never is), position according to our ever-evolving (along with ever-changing general conditions) risk/reward thesis…”
“In a longer-term, fundamental, context, the overall setup is, frankly, the definition of precarious!
Now, don’t get me wrong, that doesn’t mean that the market, even beyond the very short-term, is about to fall apart. In fact, one can argue that with the economy opening up and more stimulus in the pipeline, the odds of a major market mishap are relatively low.
But, then again, the market leadership (tech and FAANG (Facebook, Apple, Amazon, Netflix, Google) has been rolling over of late, despite all that “good stuff” to come… Which, as we know, in retrospect, typically spells the beginning of the end for bull markets…
Now, that said, it could very well be that this go-round we’re simply witnessing a rotation out of the leaders and into the previously-weaker value/reflation trades. And that, say, FAANG — rather than ultimately dragging everything with them into the next bear market abyss — are simply consolidating their post-covid gains and will ultimately resume their climb to never-before seen heights, and, alas, valuations…”
“You see, the recovery and bull market that began in 2009 followed the worst recession since the Great Depression and an historic bear market in equities; the S&P 500 gave up nearly 60% of its value. In fact, as it turned out, early 2009 marked the beginning of the longest expansion and bull market in equities on record.
Yes, truly, the harder, and the longer, the fall, the higher, and the longer, the ensuing recovery — and vice versa. Which, among other things, speaks to what has us hesitant to let the pigeons loose right here…
I mean, sure, last year’s recession was severe, and the 35% decline in stocks was painful (for unhedged portfolios), but the utter brevity of both, the swiftness of the recovery in stocks, the virtually zero purging of the excesses (read debt) — adding to them, actually — of the previous expansion, and the previously inconceivable amount of government “stimulus” haphazardly thrown into the economy, makes for a most distorted general setup.
Therefore, frankly, I struggle with how any credible analyst can proffer a bullish narrative without including bolded, large cap caveats pointing to what I just pointed to strewn throughout.”
And, in closing, wise words from an interview I watched yesterday with Huw Roberts, director of analytics at Quant Insight:
“All we can say is when macro fundamentals stop explaining the price action, it might be a question mark around how much risk you want to be running at that point, because you’ll tend to be operating in a vacuum around more transient factors rather than macro fundamentals”