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TMFPostOfTheDay (< 20)

Potential Upcoming Market Disruption?



March 17, 2011 – Comments (2)

Board: Macro Economics

Author: washcomp

I know this topic is pretty boring to some, so I'll try to minimize the numbers and give my personal interpretation.

Today's moves are giving an indication of an upcoming potential disruption in the markets. That's not necessarily a bearish comment from the standpoint of the US market, but is an indication that things must be watched closely as the game has changed and we don't know the new rules.


Japan needs money, so their insurance companies, other firms, people and presumably their government are selling "stuff" and buying yen. This stuff has included gold, Australian dollars (where a lot of money was parked to pick up the high interest rates), global equities, and presumably US T bonds (though current pricing does not reflect this).

The leader board:

The US dollar index is at 75.97, essentially the low for the year (but still somewhat above the all time low of about 70 which it briefly hit in early 2008)

The Euro has risen (against the USD) to $1.40 which is relatively high based on their obvious problems (but still far off their pre-crisis high of $1.60)

The GB pound sterling has risen to $1.61, close to its year high of $1.63 (but of course still way off historical levels)

The Canadian Loonie, after taking a wallop a few days ago, is still strong (and currently re-strengthening) at a bit over $1.02US (high for the year was $1.035US)

Big winner:

The Swiss franc is now at an all time high against the US dollar at $1.11. It is currently at 1.26 to the Euro, slightly above its all time high of 1.24 to the Euro

Current loser:

The Australian dollar (not part of the USD index) is about 3% lower against the USD than it was a week ago (this is even more pronounced when you realize that the USD has also dropped).

OK, so what does this mean to us? Jeff's theory (good, bad or ugly) is that when the USD index goes down, American equities tend to rise. While the absolute value (on a given day) is relatively unimportant, the direction and velocity are. Today's move would tend to be bullish for US equities. Assuming other currencies/equities respond similarly (never even thought about this before), this would be bullish for Australia and bearish for Japan, Switzerland (still a thought experiment at this point).

What's more important from a macro point of view is the disruption in the "world as we know it today" if the third largest economy in the world starts liquidating US debt to pay for its own problems. If this takes place at the "government level", this can be covered up by the Fed, but if at the commercial level (insurance companies et al), this could cause a drop in the price of US bonds (with an associated interest rate rise). At this stage of the game, an increase in the "long rate" will impact the mortgage market and other similar "long" debt, but more importantly, fear will ripple through the market. Higher interest rates are a headwind to equities (as the higher they get, the more likely people will gravitate with money in that direction to gain safe, predictable returns). If the move begins to move the needle on short rates, the Fed will be forced into a QEIII regardless of their wishes.

While the events in Japan are very different from what we suffered in late 2008, the symptom of a liquidity crisis is parallel. The exact way things play out over the next year is unknown, but the impact to the world economy will be felt. The "good news" (I feel uncomfortable using that word in the context of the recent tragedy) is that there are certain types of predictable companies who are likely to benefit and others which will be hit.

This is a time for careful reflection about what cards you want to hold, and which you want to discard and replace. The game is about to change, whether we like it or not, and the nature of that change, in the absence of a road map is important to consider earlier, rather than later.

On a personal note (and a general observation to those who tend to pick a single horse in the race), many are aware that my main currency bets are on the Swiss franc and the Australian dollar. I have explained that part of the rational (as I've pointed out before) for this was geographic diversity as it was unlikely for a single currency event to overtake Asia, Europe and the US simultaneously as the valuations were ratio based. The above currency movements indicate the Aussie was badly hit, but interestingly the Swiss franc was the best performer. On a total basis, from my USD centric standpoint, the needle on the sum of the two positions has barely moved. "Stuff" happens, whether to good companies or good currencies. It's frequently unpredictable. Regardless of your high opinion of a specific company, putting too many eggs in one basket is playing Russian roulette (the odds are highly in your favor, but...).

Your suggestions of either how to take advantage of this scenario or protect against the possibility of rising interest rates are important to us all.


2 Comments – Post Your Own

#1) On March 17, 2011 at 1:21 PM, ajm101 (< 20) wrote:

People should click through and recommend the original post, too.

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#2) On March 17, 2011 at 1:38 PM, Option1307 (30.43) wrote:

This is a great series, keep them coming!

I rarely venture over to the boards (I'm lazy so shoot me :)) so I really enjoy this addition to the Caps side of things.

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