Dear Friends,
In my last letter (November, 2009) I
spoke about the dangers of the leveraged carry trade and the
impact on the equity markets should an event occur that
would force the unraveling of this trade. The “carry trade”
(in simplistic terms) is where traders will short the US
dollar or other cheap currencies (borrowing) and then invest
the proceeds in riskier assets, typically emerging market
securities and commodities. They (these traders) not only
make money as the dollar weakens, but they make money on the
assets they invest in as well. In 2009, this was a lucrative
trade to make. However when that currency that is being
borrowed increases in value, then the long positions need to
be liquidated to cover the margin (dollar) position. In
other words, traders will need to cover their “loans” by
selling off their riskier assets, hence a plummet in stocks.
In the last couple of weeks we have had such a shock to
the economy and many of the associated ramifications.
When last week’s downturn in the US markets hit, we went looking for the reasons. In good part, it was due to the threat of sovereign risk, that of Greece defaulting on its debt, then possibly Portugal, needing a bailout (all combined, these countries represent a minuscule percentage of the European community). Since these countries currency is the Euro, the value of the Euro was threatened. Investor’s reaction was to dump the Euro, dump European stocks and any other stocks that might end up at the end of a “ripple” effect. Add to that, a rush to safety by selling the Euro and buying the US Dollar. It wouldn’t be as bad if investors could just buy the US dollar alone as a safe haven, but selling the Euro in order to buy the US dollar compounds the divergence in values. The resulting US dollar hit a high relative to the Euro that it has not seen since early 2009. This had a huge impact on the carry trade resulting in the massive selloff in assets. This whole effect is well articulated by Mansoor Mohi-uddin of the Financial Times http://www.ft.com/cms/s/0/f820dda4-0b37-11df-9109-00144feabdc0.html.
Other events that probably contributed to the downturn in the equity markets are the announcement by the Obama administration to tax banks .15% on any bank balance sheet over $50 billion, the fiscal tightening announced by China and India. Last Mondays announcement of the unemployment rate going from 10% to 9.7%, and the fact that the markets had a big run up in 2009 and were probably too overpriced for the level of economic activity ahead.
However, many seasoned market analysts suggest the fundamentals of the underlying economy are very good, and 2010 should bring moderate (albeit) choppy growth in the economy. Bill Miller of Legg Mason writes about the recent market decline”. I believe that this is just a market correction and that there is a buying opportunity here in the near future. As for the underlying fundamentals on the opportunities in the equity markets, he says, “the weight of the evidence continues to support a constructive view on equities for the year; we don’t think investors should be overly troubled by a down month in January.” “as – roughly half way through earnings season – 78% of S&P 500 companies have beaten bottom-line expectations. More importantly, a growing number are also beating revenue expectations” Fourth quarter 2009 real GDP growth came in well ahead of expectations at +5.7%”. “The manufacturing sector of the U.S. economy also appears to be picking up steam. On Monday (2/1/10), the Institute for Supply Management (ISM) announced that its purchasing managers’ index (PMI) rose to 58.4 in January from 54.9 in December, the largest month-to-month increase in six months”. To read more, go to http://www.lmcm.com/pdf/miller_commentary/2010-01_miller_commentary.pdf.
And “for the what it’s worth category” on Friday, ”Geithner says the unemployment report shows some encouraging signs, and that the chances of the US economy slipping back into a recession are very low”. http://www.cnbc.com/id/35281485.
For those that feel they missed out on the gold rally and that they should have invested, this recent analysis by The King Report might make you feel better. “Since the financial crisis of 2008 commenced, using Bear Stearns as the starting point, what has had the best performance among the S&P 500, the Dollar Index or gold as of Jan 29, 1010? “Gold stocks, as represented by the GDX (Gold stock ETF) are down far more than the S&P 500 since the Bear Stearns crisis.-Since the Bear Stearns crisis, the Dollar Index is +10.89%; Gold is +7.77%; the S&P 500 is -16.63% and the GDX is -27.83%. (M. Ramsey King Securities, Inc. February 3, 2010 - Issue 3689). However, note that it is gold stocks that are down, not the value of holding gold bullion which can be accessed through an ETF (exchange traded fund). And what is more interesting is the fact that the US dollar index was the better place to have had your money.
If you have been considering converting
your IRA or a portion to a Roth IRA, now may be a good time
to do so. With the recent decline in the market, your IRA is
probably worth less. Convert now as you will need to pay
the tax on those assets, so that when the market hopefully
rebounds you will have minimized the tax impact, or said
another way, paid less tax on more assets. Be careful,
as converting an IRA to a Roth IRA is a taxable event and
the amount that is converted is added to your tax basis and
could push you into a higher tax bracket. Be sure to talk
with your accountant or tax advisor first. For more details,
go to;
http://www.kiplinger.com/magazine/archives/what-you-need-to-know-about-roth-conversions.html.
As for your portfolio, stay diversified, hold bonds, and
keep some liquidity to take advantage of upcoming buying
opportunities.
My very best,
Susan
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