Monday, October 12, 2009

Mark Sellers Nails It

Mark Sellers of Sellers Capital quarterly letter is floating around. He hit a grand slam in explaining what is going on.

At present, no one expects the U.S. dollar to rise anytime soon because the Fed and U.S. politicians are printing money. Oddly, this has the disturbing effect of sending stocks up when U.S. economic news is bad, because the dollar falls and the carry trade becomes more profitable.

The conclusion is now apparent: The worse the U.S. economy gets, the more dollar-priced assets such as U.S. stocks will rise. A weak U.S. economy is required to continue the boom in the U.S. stock market. It’s nuts.

Beware, however, of the day when the Fed starts to remove money from the system. This could cause the dollar to rise, and therefore cause the carry trade to backfire quickly. Until then, though, the market will likely continue to move up on carry-trade speculation as long as the U.S. economy remains weak.

Think about that for a minute. The Fed and our politicians are fostering an environment where speculation is rampant and the money they’re printing doesn’t get used to actually help society. The Goldmans of the world will make billions on the carry trade. Meanwhile, the mom and pop hardware store down the street will go bankrupt. In fact, our stock market depends on the hardware store going bankrupt. If things start going well on Main Street, the dollar will rise, interest rates will rise, and the market will crater.


This is the first time I can remember seeing government bonds, gold, and world stocks rally significantly all at the same time. Government bonds and gold are supposed to move in the opposite direction of stocks because bonds and gold are safe havens. U.S. government bonds and gold are supposed to go up when people are afraid; stocks are supposed to do the opposite. And yet all three have been moving up together.

The rise in gold prices in conjunction with stock prices is particularly perplexing because gold is considered either a safe haven or an inflation hedge. If people are worried about the world falling apart, they buy gold. Alternatively, if people are worried about inflation, they buy gold. In either of those two scenarios, why would stock prices be going up?

The only explanation that makes sense is that there’s so much newly-created liquidity sloshing around today that people are using the carry trade to throw money at anything that moves. People expect the U.S. dollar to fall, and they don’t want to hold onto depreciating dollars. The problem is, everyone already knows that the U.S. dollar is going to fall. I know it, you know it, we all know it. It’s not a secret! How can everyone be on the right side of this trade?

For me to feel comfortable holding stocks unhedged at the current time, I’d have to be essentially making a bet that the U.S. dollar will continue to fall and so the carry trade will continue. I’m not comfortable making that kind of bet because I’m not a currency speculator. The fundamentals of the U.S. economy are not in line with the current valuations on U.S. stocks. I have always invested based on earnings fundamentals and not my thoughts on the macro environment.

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