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Published: August 24, 2009
The U.S. stock market has enjoyed a strong rally
since the early spring, but while the economy has shown
improvement, it still faces major headwinds. So it may be best
to hedge against the U.S. dollar, which is likely to experience
a significant decline over the next few months.
There are a lot of uncertainties permeating the market right
now, not the least of which is healthcare reform. Will that
reform entail a public option that could add $1 trillion to the
deficit? How is reform going to be financed? And is it going to
mean higher costs for employers across the board, or just the
healthcare insurers?
Investing is made infinitely more difficult when 18% of U.S.
gross domestic product (GDP) is hanging in the balance.
And you still have to consider:
* That unemployment is likely to keep rising, perhaps over 10%.
* That the U.S. Federal Reserve’s policy of quantitative easing
is slowing down.
* That there is almost certainly a second wave of home
foreclosures on top of the current commercial real estate
epidemic.
* And that retail sales are still a long way from recovery.
There is also reason to believe that the U.S. dollar will
continue to be weak, though it probably won’t sell off
precipitously.
The U.S. dollar has weekend against the Euro lately, having
fallen 0.8% Friday. Technically speaking the chart shows a
traditional “cup and handle” formation that could lead to an
acceleration of the dollar’s downward trend. Gold prices, up
about 13% Friday, confirm this trend and could soon break
through the $1000/oz resistance.
Fundamentally, if the economy – encumbered by high unemployment
and a relapse of the housing market – does not pick up the
dollar could be further imperiled.
Weakness in the dollar will also be affected by the Fed’s
withdrawal of liquidity, which is likely to proceed at a gradual
pace.
Finally, diversification away from the dollar among the world’s
central banks is taking place, albeit at a slower pace than many
analysts have suggested, and that too, is weakening the dollar.
Let’s concede that there is no
currency that could supplant the
dollar as the world’s major reserve
currency. So, it’s unlikely that the
world’s central banks will simply
abandon the dollar anytime soon.
However, we must also acknowledge
that a reduction in the weightings
of the U.S. dollar within central
bank reserves is already underway.
An Aug. 14 article by BNP Paribas
currency strategist Ian Stannard in
Euromoney recently described this
gradual shift in currency reserves.
The article noted that only 62.5% of
global currency reserves are in U.S.
dollars, down from about 66% in
2005.
So I do not anticipate a sudden
shift in central bank reserves, but
rather a continuation of the
measured restructuring we’ve seen so
far. Thus, the slow weakening trend
in the U.S. dollar is likely to
continue.
So, in this very uncertain
investment scenario, I prefer to go
for more secure returns in bonds.
And we can achieve great
diversification at a cheap cost with
the iShares iBoxx $ Investment Grade
Corporate Bond Fund (NYSE: LQD).
For starters, its weighted average
coupon of 6.26% offers a current
yield slightly north of 6% at
today’s prices. Investors are
assuming interest rate risk, which
means that if interest rates climb,
the value of the bond has to come
down. But in the short term, there
is no immediate threat of inflation.
Looking at the major holdings of the
fund – which has no single position
that accounts for more than 1.26% of
its total holdings – I see some
names that have demonstrated
continued stability and others that
have shown recent signs of
improvement, such as American
Express Co. (NYSE: AXP). So I do not
expect any major credit spread
hiccup here. I certainly do not see
any hiccup that a 6.26% coupon would
not compensate for.
For an additional hedge against
dollar weakness, I recommend iShares SPDR Gold Trust ETF
(NYSE: GLD). You may also consider
buying a bit of the PowerShares DB
US Dollar Index Bearish (NYSE: UDN)
fund. Do not go overboard. Err on
being light, rather than heavy on
hedging, since timing currency moves
is very difficult.
-- Horacio Marquez
Contributing Editor
MoneyMorning.com |
