Third Market Strength


Two recent lessons have shown two potential market strengths that suggest the current downturn may not be the big one. This lesson looks at a third market strength in the position of the US business cycle.

If you need to refresh your memory on the other two market strengths you can recall those two lessons here.

Here is how the business cycle works.

ASSET ALLOCATION

The best time to buy equities is during economic downturns. This down part of the cycle (the economic downturn) has been stalled for ten years. We should have seen the middle scenario (the downwards trend) after the 1998 US stock market correction. The US government in its infinite wisdom (please note the tongue in cheek) decided to create a real estate boom instead.

This was not all the US government’s fault by a long shot. Nor was the false stability created just by extra liquidity that pushed up prices (not values) of property.

The banking community joyfully jumped in, plus big investors had finally caught onto borrowing low in one currency and depositing high in another.

Japan factored into this as well. Still trying to recover from the 1990s crash in Tokyo, Japan kept its effective interest rate at zero!

Huge yen loans pumped back into stock markets helped buoy everything up.

So two credit expansions kept the economy inflating and bloated.

This created a weird social economic mix where employment remained high, inlfation was galloping ahead but interest rates were low.

Finally forces adjusted and viola…we had a credit crunch! The low interest scenario is still true but in a different sense. The low interest loans are now very hard to get and the economic scenario is looking very much more like it should.

We have the inverted yield curve…short term loans can cost more than long ones. There is the rush for liquidity. Monetary authorities have relaxed the oney supply…big time…globally. I am not sure that we have the high level of unemployment yet…but the election is just a short distance away and administrations have learned to take pain early…so it is likely to come. Certainly there is a high level of uncertainty!

In short this is the classic set of conditions to buy equities.

The global economy may be headed for a major economic slow down. But maybe not yet. As we saw in an earlier lesson the 30 year cycle suggests that time is still three years ahead.

Seasonality also suggests that US equities will get a next month in the November to April push.

Here we see that the economic cycle is in a position to create the best equity buys we have seen in decades. This may be the best buying opportunity we will see in our lifetime…if we stick to our search for value.

We also need to look for value in the currencies we hold. This point is magnified by a question this multi currency student sent:

Q: Gary, what currency mix should someone holding say 500,000 GBP in cash invest in? (I’m intending to move money from the UK into Swiss and possibly Australian Bank Accounts).

Note: For now I have a base in the UK along with Swiss and Australian Bank Accounts and will soon decide where in the world I want to have a more established place to live.

A: My approach up to this time has been based on the belief of Europe’s stability. Now I expect more inflation in the US AND Europe.

Where does an investor go when the euro is no longer trusted and the dollar is fundamentally weak but suddenly flexing muscles it should not have?

My guess was (and here I am overweighted ) that investors would lean towards currencies of small, economically sane, solid, established, politically sound countries…such as Britain, Norway, Sweden and Denmark. I expected these currencies to rise versus the euro and dollar. and felt they were least likely to fall versus the euro.

This strategy worked well over past years but now if the euro weakens (in purchasing power terms) so too will these currencies. Plus Denmark and Britain both had their own financial bailouts which makes the pound and kroner suspect.

I am liking emerging currencies more now.

I believe that the global financial bailouts in major economies will create inflation everywhere. Mature economies may cope less well with inflation than emerging countries that are used to inflation.

In addition there has been a dramatic rush to the dollar away from emerging currencies. This is in part because many investors had borrowed US dollars to invest in higher yielding emerging currencies. A massive emerging sell off and swtch to dollars to repay the laons has pushed emerging currencies down versus the greenback. You can see an example of this in the Brazilian chart below from www.finance.yahoo.com. You can get current charts there. Every chart I reviewed shows the same story. The dollar has fallen steadily against these emerging currencies for five years. Then there is a sudden turn around.

5y Brazil chart

So I will add to my emerging currency position.

Here is my current currency breakdown:

US & Ecuador Real Estate 50.12%
Europe EUR 16.05%
Denmark DKK 9.03%
United States US$ 8.46%
Britain GBP 4.01%
Sweden SEK 3.16%
Hungary HUF 2.37%
Turkey TRY 2.1%
Brazil BRL 1.28%
Canada CAD 1.18%
Norway NOK 1.15%
New Zealand NZD 1.09%
Australia AUD 0%

I am looking at seasoned bonds in Brazil, Mexico and Hungary to start.

I am also switching my real estate from a buy and resell mode to buy and rent. Holding good, free and clear rental property makes a lot of sense to me now.

Since this subscriber mentioned where he intends to live, let’s look at the impact to those living in a nation when its currency is beyond its control and is falling in value…as is likely in Australia…a rich country, where like the US, the government spends more money than it has.

I worry about oil currencies such as the Australian and Canadian dollar. Remember the US surplus? Based on a short windfall created by the 1998 stock market boom, the US increased spending…exactly at the wrong time. How many spending plans have been made in Canada and Australia based on $200 a barrel oil?

This seems silly with oil below $70 a barrel. Government officials should not be speculators but political pressures forces them into it.

There are very few, old traders. Young men and young women do this job because experienced investors know that currency trading requires immense capital, continual diligence, almost unlimited discipline and the ability to absorb many small losses before making a big hit. Plus traders must have the emotional stability to not let the big lead them astray!

Elected political figures rarely have any of these traits.

I am also not a Swiss franc fan either and have warned against them for over a decade. See why in our archives.

However just because this reader has banks accounts in Switzerland and Australia does not mean he has to overweight his portfolio in these two currencies

Two important lessons of purchasing power are:

#1: The currency of the country where you live does not matter much. The currency of your pension, your investments and savings is what counts.

If you live in a country with a weak currency and your investments or pension income is in a stronger currency then your cost of living normally falls. For example if you live in Ecuador but invest in currencies that rise against the dollar, this is good!

#2: You do not have to hold currencies just of the country where you bank.

In this case the subscriber who asked this question could have a diversified currency portfolio similar to the one shown above all held in his Swiss bank.

In these turbulent times, stay diversified and keep looking for value in equities, bonds and currencies.

The next two lessons will update Michael Keppler’s equity market value analysis.

Until then, good global investing to you.

Gary

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