Oct 20, 2007: How I learned to stop worrying about the U.S. Dollar

  • It's a Tug of War
  • Inside Dr Strangelove's mind
  • Current ETF rankings (and a fair warning)
  • It's a Tug of War

    It is April 26th, 1982. Paul McCartney's "Tug of War" Album debuts with a funny song: "The Pound is Sinking". It starts like this:

    The Pound Is Sinking
    The Peso's Failing
    The Lira's Reeling
    And Feeling Quite Appalling

    The Mark Is Holding
    The Franc Is Fading
    The Drachma's Very Weak
    But Everyone's Still Trading

    Fast forward 25 years -- sometimes you need many years to put things in perspective -- the once sinking Pound Sterling recently hit a high of 2 US Dollars. From a low of about 83 US cents per one Euro in October 2000, the Euro is up over 70% vs the dollar. You now need only 0.70 Euros to buy one Dollar. Yet, the Dollar keeps falling.

    Many people are worried about the Dollar. I took a page from Dr Strangelove, seriously. Not that it is much fun. I remember how cheap was our 2002 trip to the Canadian Rockies, when one US Dollar used to buy 1.6 Canadian dollars. They are now on par, oops, the US Dollar is a bit lower already.

    Why is the US dollar so weak? There are several reasons. For starters there's too many US Dollars in hands that don't need more of it.

    Trade gaps cause countries like China and Oil exporting countries to have hundreds of billions of dollars in surplus, and the US continuing trade deficit makes this balance unlikely to change soon. More Dollars need to be printed, which keep its value down. At the same time, Oil (which is a proxy to the dollar sinking, because it is denominated in dollars) keeps rising. When the media flashes headlines like "Oil hits new high" ask yourself is it really oil hitting new highs or rather the U.S. Dollar hitting new lows.

    To add insult to injury, the US government keeps spending like there's no tomorrow. Government debt, money printing, and issuing of US treasury bonds are all at all time highs. And then, there's the lowering of interest rates which makes the Dollar even less attractive.

    So will the Dollar keep sinking? Probably. A long term recovery of the Dollar is very unlikely against a backdrop of record trade deficit, record government debt, excessive money printing, and interest rate reductions. Will the Dollar sink another almost unthinkable 25%, or 30% against the Euro on top of the over 70% it already went through since 2000? When will the inevitable reversion to the mean finally start taking place? I don't really know, and fortunately, I don't need to know. Betting on currencies relative direction is not something I feel confident about. But don't despair, there's a simpler way to survive this. Read on.

    Inside Dr Strangelove's mind

    My view is that much the smart money, except huge holders like China which cannot possibly move fast, is already diversified. This includes oil exporters buying Euros, and investors like you and me shifting a significant proportion of their portfolios to non-US assets for a long time now.

    The large Dollar surplus of countries like China means that at a certain point Chinese entities will start buying assets in the US just like the Japanese did in the 1980's. They could buy real estate, or whole companies. Remember Lenovo buying IBM's PC business? Multiply this deal many times over. This looks like the most sensible way to deploy all these surplus dollars back into the continent without causing too much of a world-wide monetary shock.

    We should also realize that part of the great appreciation in the markets is a reflection of the fact that each dollar is worth less, and that big multinational companies which sell their goods globally, are doing just fine, thank you. See this chart on the right, of McDonald's vs the S&P500 and the DJI in the past year.

    So what would Dr Strangelove do? Simple.

    Moving away from Dr Strangelove's mind, what do our models say? Not surprisingly, exactly the same thing. When I look at the top 40 ETFs as ranked by my favorite ranking function, MMVR, I find:

    Which brings us back full circle to the current ETF rankings.

    Current ETF rankings

    In this Friday's ETF rankings, the dominant themes remain: Large-cap international and multi-national stocks, Oil & Energy, Telecoms, Materials, and a few, select reasonably-valued countries from Asia and Europe.

    A few warnings are in order:
    • Spain: the real-estate bubble there may be very similar to the US, and close to popping, so I would avoid it for now.
    • Also: even though we had a down week with a very bad Friday, the markets are way over-extended at this point. The past 2 month rally has been extreme. I would sit on my cash and wait for a much deeper correction before committing anything even to these top 40 ETFs.
    • I would still avoid a few which rank. In particular, Utilities, Aerospace & Defense, and Environmental Services, which are a bit too high on the valuation scale, even though their momentum looks great. Remember, momentum can cut both ways. Never buy overvalued assets.

    Using mmvr ranking method on 20071019
    1        2.9129 EWG     iShares MSCI Germany Index
    2        2.6781 ADRU    BLDRS Europe 100 ADR Index
    3        2.6588 DKA     WisdomTree Intl Energy
    4        2.5717 EWY     iShares MSCI South Korea Index
    5        2.4408 IXP     iShares S&P Global Telecommunications
    6        2.3244 XOP     SPDR Oil & Gas Exploration & Production
    7        2.2223 DBN     WisdomTree Intl Basic Materials
    8        2.2028 IXC     iShares S&P Global Energy Sector
    9        2.1979 DGG     WisdomTree Intl Communications
    10       2.1544 DBU     WisdomTree Intl Utilities
    11       2.1490 IEO     iShares Dow Jones US Oil & Gas Ex Index
    12       2.1325 PXE     PowerShares Dynamic Energy Exploration
    13       2.1300 EWP     iShares MSCI Spain Index
    14       2.1089 EWT     iShares MSCI Taiwan Index
    15       2.0867 XLE     SPDR Energy Select Sector
    16       2.0750 FEZ     streetTRACKS Dow Jones Euro STOXX 50
    17       2.0606 EWC     iShares MSCI Canada Index
    18       1.9977 ADRD    BLDRS Developed Markets 100 ADR Index
    19       1.9849 IGE     iShares Goldman Sachs Natural Resources
    20       1.9831 VDE     Vanguard Energy VIPERs
    21       1.9379 MXI     iShares S&P Global Materials
    22       1.9368 EVX     Market Vectors Environmental Services
    23       1.9326 IYE     iShares Dow Jones US Energy
    24       1.9053 DWM     WisdomTree DIEFA
    25       1.8898 PUA     PowerShares Dynamic Asia Pacific
    26       1.8827 EWN     iShares MSCI Netherlands Index
    27       1.8764 DOL     WisdomTree Intl LargeCap Dividend
    28       1.8510 DOO     WisdomTree Intl Dividend Top 100
    29       1.8488 VWO     Vanguard Emerging Markets Stock VIPERs
    30       1.8063 DNH     WisdomTree Pacific ex-Japan Hi-Yld Eq
    31       1.7995 EZU     iShares MSCI EMU Index
    32       1.7736 XME     SPDR Metals & Mining
    33       1.7666 IYM     iShares Dow Jones US Basic Materials
    34       1.7662 PPA     PowerShares Aerospace & Defense
    35       1.7562 VAW     Vanguard Materials VIPERs
    36       1.7065 DND     WisdomTree Pacific ex-Japan Total Dividend
    37       1.7021 EZA     iShares MSCI South Africa Index
    38       1.7018 TTH     Telecom HOLDRs
    39       1.6867 GMM     SPDR S&P Emerging Markets
    40       1.6572 JXI     iShares S&P Global Utilities

    And that's about it for this October. I hope to write again sometime in November.

    As always, any feedback, question, request, criticism etc. is very welcome.

    -- ariel