October 28, 2008
Who’dathunkit? A Stronger Dollar, A Market Breather & The Return of $2.00 Gas.
In this newsletter I’ll discuss the strengthening dollar and why I believe that the stock market is behaving exactly as it should. I’ll also tell you what to do if your home equity line of credit is cut off, give you an update on our investment strategies and revisit some topics from the past.
The Dollar Is Strong? Who’dathunkit?
The stock market gyrations are not the only strange thing going on. The dollar, accustomed to having sand kicked in its face like a 98 pound weakling on the beach, is now the strongest currency in the world – by far. What’s going on with that?
Just like when you travel abroad you have to buy local currency to use, investors also need to buy local currencies to purchase investments. Over the past few years there has been a lot of investment overseas, and those currencies were in greater demand than ours.
Now, once again, everyone wants to own dollars so they can buy T-bills, CDs or just be out of what are recognized as weaker currencies. The US, despite all the political rhetoric to the contrary, is still considered the safest of the safe havens.
But there is more driving the dollar right now.
I had breakfast a year or two ago with Richard Russell, writer of the Dow Theory Letters for almost 50 years, and his lovely wife Faye. Richard pointed out that having debt is like a “short” on currency.
Shorting involves selling something you borrow, generally a stock, hoping to buy it back at a lower price to replace the borrowed stock and make a profit. This is measured by the difference in what you sold for and what you it bought back for. If the price goes up, you can lose – sometimes a lot, because, theoretically, the price can go up forever and you have to replace the stock regardless of how much you have to pay to get it.
Richard Russell was pointing out that eventually the credit cards, mortgages or car loans need to be repaid and one has to find the dollars for this somewhere regardless of the cost to get them. Often other assets get sold to pay off the debt and sometimes the dollars needed are very expensive in terms of the cars, trips or real estate it takes to raise them. This is exactly what is pushing the price of the dollar up and the price of a lot of other assets down.
Except that in the case of investment firms, hedge funds, banks and insurance companies, they almost all used a lot of leverage in their investments. Leverage is using other people’s money to make money. For each dollar you owned you could borrow an equal amount of other folk’s dollars – or maybe 10 times. In the case of Bear Stearns, Lehman Brothers and Merrill Lynch it was 40 times. All of that debt had to be repaid – or else – and the amounts were huge compared to what you and I might be able to borrow. That’s why Merrill, Bear and Lehman are gone now.
So as long as debt is being paid down – debt denominated in dollars – I expect the trend of a strong dollar will continue.
Don’t Look Down!!
The stock market is behaving normally. Remember, you heard it here first. Despite its stomach flipping rallies and declines the markets are actually performing exactly as the text books say they should. So what does this tell us to expect from the markets going forward?
And what it seems to be doing now is going nowhere in a very interesting way. The volatility-3%, 4%, 9% moves in one day that seem commonplace now- is very extreme. We went 3 full years in 2004-2006 without a single 2% loss day. Today, a 2% loss is a yawner.
This volatility masks the fact that the low of the stock market may be two weeks behind us. The low was created on October 10th at 839.80 on the S&P 500 Index**. This low has been approached a couple of times, but not broken since then. This is a good sign.
We never know exactly why this price level seems attractive enough to coax investors into buying, but it has happened 3 times in the past two weeks. The bottom has held. Unless that changes, look up, don’t look down for stock market movement.
If this turns into a good solid bottom for the stock market I think it will produce a tradable rally, one that will last months. However, my guess is that it will not be the end of the bear market, merely a welcome breather.
What To Do if Your Home Equity Loan is Cut Off.
Bankers are notorious for telling prospective borrowers everything except “we don’t have any money.” Just the idea that a bank may be low on cash is enough to cause a run, so they always tell borrowers that they need another document (usually impossible to get), or that there is some vague credit issue. These days, banks just aren’t making many loans, period.
Many homeowners have also been cut off from lines of credit previously tied to the equity in their homes. If you had counted on your home equity to be your piggy bank, not being able to tap into this source of savings can upset a lot of plans.
In some cases this may relate to falling home values providing less collateral than the bank is comfortable with. More often, I suspect, the banks just don’t have the cash to loan out. The message I would convey if you have run into this problem is try not to take it too personally. It is a reflection on the economy or the bank, much more than a reflection on you or your credit worthiness.
But what should you do if you are caught in a cash squeeze because you were counting on your home equity piggy bank to be available when you needed it?
Your bank probably made a blanket decision and cut everyone off at the same time. A bank officer may be able to review the particulars of your circumstances and make an exception for you. But you have to ask. If your only point of contact is an 800 number, ask to speak to a supervisor. Be prepared to outline improvements already made to your home or planned with this new money.
Credit unions may be easier to deal with than commercial banks since they are in the business of working with individuals and did not get as caught up in the default frenzy that cascaded through the banking system.
If you have good enough credit and good enough collateral the money is there. Don’t give up.
How’s My Crystal Ball?
My August 11, 2008 newsletter said get ready for $2 gas at a time when we were still paying around $4 here in Arizona. More than a few of you thought I was crazy. Some of you even told me so.
Remember where you heard it first.
Real Estate Rebound In Sight?
I said several times last year that this real estate decline was going to be a big deal. A lot bigger than anyone expected. And still, I am astonished at how low it has laid the economy and the markets.
My October 2, 2007 newsletter stated that I expected home prices to drop 8.3% by November of 2008. How did I do on that one?
Today, the data indicate another two years of declining housing prices, with 9.14% of the decline expected between now and November of 2009. After 2009 the declines become smaller, pointing to a possible bottom in the housing market in 2010. I’m glad that a bottom is in sight. I just wish it were closer than 2010.
It would be nice if I could sugar coat this a little since almost every client of mine is a homeowner, but this is what I am seeing. The bottom in home prices still looks a long way off.
My May 10th 2008 newsletter suggested that we could not expect a bottom in the real estate market until there was an entity like the old Resolution Trust Corporation (RTC) to move properties the government ends up with back into private ownership.
One bit of good news was the $700 billion Troubled Asset Relief Plan did create the entity I was looking for.
If history is any guide, though, the real estate market will not get a quick boost from this. In 1989 the federal government created RTC. It took a year to get it functioning, another year for the stock market to bottom out, and yet another year before real estate prices firmed up and began rising again.
Real estate cycles are long ones.
Someone once said, “I’m getting so old I worry that my friends in heaven will think I didn’t make it.”
One good thing to come out of all of voter registration fraud going on is that we finally know where to find Osama Bin Laden. He lives in Nevada, Florida and Ohio. (Thanks to Argus Hamilton for that one)
Our Flexible Income* strategy remains 100% in the money market or short term treasury notes which are immune from default. The actual investment being used is the Lehman 1-3 Year Treasury Fund, and after a couple of anxious calls from clients I should explain that Lehman Brothers merely developed the formula used to buy the treasuries, but they do not hold your money. This is a very safe place for money. That is why we are in the Treasuries right now.
I would like to buy an investment that will benefit from the rise in the dollar, but I am hesitating to do so right now. The value of the dollar has exploded upward, sort of like the stock market exploded downward, and it needs to take a breather – meaning it needs to come down a little – or I’ll worry about a decline right after I buy. Losing an opportunity is easier to take than losing money. But I am watching investments in the dollar. The bond market in general is still too volatile for my comfort.
Even our municipal accounts* are out of the market, sitting safely in short term treasuries. Normally I use hedging techniques to stabilize principal values for municipal accounts, but the normal hedges are based on US Treasury interest rates and normal relationships between munis and Treasuries were disrupted for a while. I decided the best thing to do was sit this one out for a bit.
Careful Growth* accounts are still 60% out of the market with short term treasuries and money market funds making up the majority of holdings. I did a little buying since the last newsletter since there is a chance that the market’s bottom may be in.
Being 60% out and only 40% invested tells a lot about my overall confidence level in the market, but let me give you my rationale for this trade.
If the market breaks significantly through its recent lows-indicating the decline is continuing-I will quickly sell and cut any losses. We have a risk of about 4 to 5% of portfolio value if this happens. However if the market moves up from here the profit potential on the trade could be as high as 25%. To me that is a good risk/reward tradeoff – a risk worth taking.
A recent report from PMFM Management, mentioned that according to Morningstar, which reports on nearly 10,000 mutual funds,(as of 10/24/08) only four funds in the U.S. equity sector have lost less than -10% year-to-date and the average fund is down 42%. Not us though. Currently our Careful Growth* portfolios have losses in the single digit range for the year. Although I just hate any losses at all, our performance would put our Careful Growth*accounts at the very top of the performance list (if we were a mutual fund).
This is the essence of my management style – to preserve principal as much as possible in bad times and keep up with the markets in good times. It is working. Tell your friends.
Our socially screened accounts* follow the same signals as our growth accounts*. They are also 60% out of the market and 40% invested in a socially screened index.
I noticed that Warren Buffet announced he is buying stocks just a few days after I had begun to do the same thing. I wish the guy would quit trying to copy me. (He said jokingly).
*The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.
**The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market. Investors cannot invest directly in the S&P 500 Index.