Tuesday, September 6, 2011

Conventional Wisdom (cont.)

A supposedly sure bet has been that the U.S. is in inexorable decline, and its bonds and currency should be shorted.  It followed that in times of crisis, or at least unease among market participants, the remaining havens were gold and the Swiss franc.  The franc's rise had been extraordinarily sharp for a major currency, and earlier this summer it had become approximately 25% overvalued on a purchasing-power-equivalent basis relative to the dollar.

But as we've seen in various markets, momentum can overwhelm reason--until something changes.  And today something did change for the franc, as the Swiss government imposed a ceiling on the currency's value.  It has fallen approximately 9% today against other major currencies.  The Swiss franc ETF has now fallen 18% from its recent peak.  Going into today's trading, it had risen 30% over the past three years.

For the U.S. and its currency, however, market expectations could hardly be lower.  The national government seems incapable of dealing with the country's problems, and the economy seems on the verge of an extended period of Japan-like stagnation.  

China, on the other hand, reminds me of Japan in the late 1980's, when it seemed poised to take over the world, as it bought major U.S. assets such as Rockefeller Center and Columbia Pictures.  Savvy people were learning Japanese in anticipation of a sustained period of Japanese dominance.  Today it is China in that position.  

I think a major surprise could be that China has major problems that are not widely expected.  With fixed investment at nearly 50% of Chinese GDP and its export markets way down, a major glut--and bank loan losses--loom.  If China does have major problems, the decline in the standing of the U.S. could be reversed for a while.  

The U.S. dollar could have a countertrend rally, which would pressure the reported earnings of major U.S. multinationals, which earn 50-60% of profits overseas.  That would not be good for stock prices but despite this risk, I still find a number of top-quality U.S. and foreign stocks at attractive valuations.  And when valuations are compelling I advocate buying, as there is much room for things to go right when a stock is cheap (and much to go wrong when a stock is expensive and in vogue).  With the baffling volatility of markets these days, I suggest using limit orders at prices that valuation analysis support.

Steve Lehman

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