Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

All Quiet on the Western Dollar Front

The funding crisis is definitely gaining steam, in our opinion. With European and US failures to bail out or stimulate their respective economies, governments around the world are beginning to repatriate funds to avoid a crisis at home.  Foreigners or foreign banks cut their holdings of US Treasury debt in June for the first time in more than two years.  The group of sellers includes Japan (the second largest buyer), Brazil, Russia, Hong Kong, and a group that makes up the Caribbean Islands (tallied as the fourth biggest buyer).  This is in direct contrast to the crisis of 2008, in which these entities accumulated, in exponential fashion, US securities either as a safe haven or to stave off economic disaster here in the world’s largest consumer base.

So far, Treasuries have enjoyed a lift from US fund companies that are still finding bonds a viable substitute for stocks. With the exception of China, which still has an appetite for US debt, no matter the season (which should tell you something about China), support for our markets and for our dollar (more on this below) is showing very few signs of life external to our shores.  Flight capital is either being sent home, aiding respective foreign currencies and/or bond markets, or it’s finding its way into stores of value such as gold.

In the US markets, stocks declined to the benefit of bonds once again.  For the week, the Dow, S&P, and Nasdaq all fell 2.19%, 2.63% and 4.16%, respectively, while Treasuries rose, with shorter maturities gaining the most on the curve.  The 10-year Treasury sits at a near record low of 2.06% and the 30-year at 3.39%.  Although the 30-year has gained nicely – it is still 100 basis points higher than 2008 crisis levels – the underperformance compared to the 10-year may be indicating that future inflation expectations are a concern.  Along those lines, the continuous commodities index is showing reluctance to join in the freefall that is stocks, rising 1.86% for the week – favoring the softs and the metals, as oil dropped over 3.0%.

US economic data was mixed, but the already sensitive markets chose to respond to the weak side of the data.  Of note, inflation surprised to the upside, with the CPI, PPI, and the import price index all registering noticeably higher than expected month-on-month and year-on-year increases.  Initial jobless claims broke back above the critical 400K mark, producing 408K in claims as of August 13th, and the Philadelphia Fed manufacturing index fell 33.9 points to -30.7 at its mid-August read.

On the other hand, deeper cyclical areas such as housing and corresponding mortgage applications were once again stabilized on the heels of the lunacy in bonds.  The LEI also came in higher than expected, responding to more monetary easing – more on this below.

Earnings from the likes of Lowes Corp failed to impress this week; even though they beat “the number” by two cents, the stock ended mildly lower for the week.  Lowes’ same-store sales (those open more than a year) declined 0.3%, missing the 2% expected increase.

Overseas markets saw much of the same kind of action. Stocks fell hard – even harder than US markets – and bonds rose in the flight to capital.  Frances bourse and Germany’s DAX are now off more than 25% from their April highs (worse than the Dow’s 15%).   Bonds in these respective countries have performed in much the same manner as they have in the US

Sparking Europe’s sharp selloff this week was Germany’s GDP report, which rose only 0.1% ; +0.5% was expected. This, combined with the failure of the Merkel-Sarkozy plan to rehabilitate old PIIGS friends, sent European and US markets back to their recent lows – which they did not break.  Chinese economic growth was also trimmed from 9.5% to 9.2%, while Chinese newspapers increasingly blame US debt worries as the cause for the slowdown.

Through all of this motion and commotion in the markets, the US dollar has gone nowhere – unlike in 2008, when the dollar spiked hard on crisis moves in stocks.  We have to admit that even we are taken aback by the severity of the dollar’s rejection in international markets – thus far.

The Fed must also be perplexed and concerned, given that this weakness in the dollar has kept commodity prices firm – likewise inflation, putting a damper on any hoped-for effectiveness in a new “QE.”  That said, however, the Fed is active, monetizing some $2.909B in Treasuries for the week ending this past Wednesday – without a corresponding public announcement.  It’s apparent the Fed realizes both the dire need for QE and the inflationary danger of making that need public.  In any case, as we have been saying, the Fed is trapped, along with the politicians, in curing our ailments.

We have given some credence to the idea that the metals, especially gold, are due for a pause in their recent ascent.  This being an expiration week for the metals, where gaming prices higher is par for the course, we may see some fade to the “hockey stick” chart formations in the following week.  However, with very little support for our dollar and the Fed’s desire to print again, this weakness may be short lived … stay tuned.

Best regards,

David Burgess
VP Investment Management