Sunday Edition: The Mighty Dollar

January 29, 2017

Sunday Edition: The Mighty Dollar

Several weeks ago, I wrote about how I believe it’s possible to time financial markets with a high degree of accuracy.

In today’s article, I want to discuss the US dollar and why I believe it is nearing a long-term top (sometime in the next 6 to 18 months), and how you can use this trend change to make a small fortune.

In the November 27, 2016 Sunday Edition, I wrote the following:

“I do believe it’s possible to identify key characteristics that are present at or near every major turning point in virtually every market. Identifying these characteristics can help you get “close” to a major turning point, but you will never be exact without a little luck… When you understand the degree to which human emotions play a role in the trends that develop in financial markets, it becomes easier to identify major turning points. As markets move higher, greed, complacency, and euphoria increase. As they move lower, fear and panic increase. When these emotions reach an extreme, the probability that a major turning point is near at hand increases dramatically.”

There are many ways to gage investor sentiment to determine when it may have reached an extreme. One interesting phenomenon that often occurs near a major market turning point is a market which has been displaying a strong and persistent trend will make the cover story of a major magazine.

The slant of the article will support the prevailing trend that has been in place for long enough that investors come to accept that trend as the “new normal,” believing it will continue indefinitely.

However, when something becomes so accepted among the general investment public, the prevailing trend is at risk of a major reversal.

Let’s quickly look at a few examples, then we’ll look at the eight year uptrend in the US dollar that began in 2008 to see what the future may hold and the best way to position your portfolio.

BusinessWeek – August 13, 1979

The August 13, 1979 issue of BusinessWeek ran a cover story titled “The Death Of Equities.”

The article took an incredibly negative or bearish view toward equities with no expectation for them to improve anytime soon. To a contrarian, this makes perfect sense. The Dow had topped out at 990 in 1966 and would see-saw back and forth between roughly 600 and 1,000 over the next 17 years. Inflation was a persistent drag on the economy and interest rates were steadily rising.

Here are a few excerpts from the article to give you a feel for the general investment mood at the time:

“The masses long ago switched from stocks to investments having higher yields and more protection from inflation. Now the pension funds–the market’s last hope–have won permission to quit stocks and bonds for real estate, futures, gold, and even diamonds. The death of equities looks like an almost permanent condition–reversible someday, but not soon… Pension fund money can now go not only into listed stocks and high-grade bonds but also into shares of small companies, real estate, commodity futures, and even into gold and diamonds…

“As investors have fled equities, so Wall Street, to survive, has fled them, too… ‘Anybody who thinks that it will be easy sailing for Wall Street during the 1980s is dead wrong,’ says James Balog, senior executive vice-president of Drexel Burnham Lambert Inc. in New York. ‘There still are many problems that we must deal with.’”

As you can see, as 1979 was coming to a close headed into 1980, the prevailing belief was that inflation would persist, equities would continue to perform poorly and should be avoided, and hard assets such as gold, diamonds, and real estate were better alternatives.

The funny thing is, both gold and interest rates topped out in 1981/82 and entered very long term bear markets. Gold finally bottomed in 1999/2000, but rates have continued down (bonds up) into July 2016, and now finally look to have bottomed.

The truth is equities were nothing but “easy sailing” during the 1980s. Yes, there was the ‘87 crash, but it was nothing but a blip on the chart as equities continued their unrelenting ascent throughout the ‘90s as well. Based on today’s S&P value of 2,296, the index has increased 17-fold from the 1981 year end closing price of 122.55.

Gold, which the herd was rushing into, performed horribly over the next 20 years and bonds, which to the general investment public must have seemed like a one-way losing bet with the 10-year note yielding nearly 15%, further outperformed equities by a ratio of 5 to 1.

Yes, hindsight is 20/20, but as investors, we can never underestimate the herd mentality of the crowd, and should be looking to position ourselves in a contrary fashion when the prevailing belief becomes too lopsided. In the very least, don’t get caught up in following the crowd.

Contrary to the BusinessWeek cover story and the extremely pessimistic opinion toward equities, the summer of 1979 would have been an excellent time to jump into equities to ride one of the greatest bull markets in history. And a really bold investor, who shorted interest rates by going long bonds, would have done even better.

Let’s look at one more quick example to substantiate that the herd mentality is always wrong at major turning points, and that a major magazine cover story can be good indicator of when the herd is “running off a cliff.”

Here is the June 2005 cover of Time Magazine:

Time Magazine – June 13, 2005

The “flavor” of the article was how disk jockeys, hairdressers, and Taco Bell cashiers were making fortunes flipping houses. Here’s an excerpt:

“You shouldn’t get the impression that you can make six figures in real estate by snapping your fingers. Just ask Max Kaiser. It once took him a whole hour. The South Florida real estate investor bought a Miami-area two-bedroom luxury condo–which had not yet been built–for $425,000 last year. After signing the purchase papers, Kaiser, 32, heard that a couple outside the developer’s office was interested in the same apartment. So he sold it to them on the spot for $525,000. ‘I heard it’s now going for $570,000, but what can you do?’ he says. Don’t cry for Kaiser. Four years ago, he was an accountant, stultified by his job. Now he’s pricing Porsche Carreras.”

Within 15 months, the greatest real estate bubble in history reached a top and came crashing down.

The Economist – December 3, 2016

Now let’s talk the US dollar which recently (December 3, 2016) made the cover of The Economist.

The article is obviously dollar bullish. However, it does raise some concerns about the dangers of a strong dollar. Here are a few of the “bullish” excerpts:

“THE world’s most important currency is flexing its muscles…”

“…The dollar has been gradually gaining strength for years. But the prompt for this latest surge is the prospect of a shift in the economic-policy mix in America. The weight of investors’ money has bet that Mr Trump will cut taxes and spend more public funds on fixing America’s crumbling infrastructure…”

“…America’s relative clout as a trading power has been in steady decline: the number of countries for which it is the biggest export market dropped from 44 in 1994 to 32 two decades later. But the dollar’s supremacy as a means of exchange and a store of value remains unchallenged.

Do I believe the US dollar will collapse tomorrow? Hardly. But I do believe that the bullish trend in the US dollar, and corresponding bearish trend in the emerging market currencies of Brazil, Russia, China, and India, as well as many others, is nearing a major turning point.

And that brings me to the point I want to make. When you invest in emerging market companies, you have the opportunity to profit as the share price increases in value, but you are also subject to gains and/or losses based on currency fluctuations, which many domestic investors often overlook.

That’s why having an emerging market expert like Sven Carlin is so valuable to your long-term investment success when diversifying outside the US (or your home country) into the fastest growing emerging markets in the world.

Here is what Sven wrote in the December issue of Global Growth Stocks about his two Brazilian stock picks:

Pick #1:

Given [company] history, we can expect similar earnings to the 10-year average earnings of R$3.9 per share. This would translate into $1.14 per share or a cyclically adjusted PE ratio (CAPE) of 7.44. When the Brazilian currency rises to a healthier level of R$2.5, we can expect [company] to deliver an average EPS of $1.56. This would then also be valued at a higher than current market valuation, which gives [company] a 100% increase with a PE ratio of 10 and an almost 400% increase with a PE ratio of 20.

Pick #2:

[Company] current price is $2.08 per share. Its book value is $3.33 which creates a nice long-term margin of safety. Past average earnings are $0.56 per share. Given the management’s EBTIDA guidance, we can expect similar earnings in the future. This would translate into a future PE ratio of 4 and a dividend of $0.28, giving a 13% yield. As it’s extremely unlikely that [company] remains at these valuations with such results, I estimate a long term real value of $5.6 for [company] derived from a long-term PE ratio of 10 which should be given to [company] when the situation in Brazil stabilizes and concession agreements are clear. This target can increase if the Brazilian currency appreciates as things improve in Brazil. An exchange ratio of R$2.5 for $1 would translate the R$1.96 earnings per share into $0.78. That, with the same valuations as above, gives a target price of $7.8. As a similar valuation to what the Chinese have paid for [competitor], it would give a target price of $18.72. This is a bit stretched, but don’t forget that [company] was trading $13.38 per share back in 2012.

Notice how Sven, in his future targets for the emerging market companies he recommends, takes into account currency fluctuations and how they can add to your overall return potential.

We are excited to be beta launching Global Growth Stock in mid-February. If you haven’t added your name to the fast growing list of investors who have expressed a deep interest in Sven’s work, click here to be automatically added.

Charter Subscribers to Sven’s Global Growth Stocks will receive a deep discount off the regular annual subscription rate.


Shane Rawlings
Founder, Investiv