From January to the end of August 2010, the US dollar rallied about 20% against a basket of world currencies. Over that same time frame stocks sagged and the S&P 500 lost just over 6% for the first 8 months of 2010. Then the rumour of QE2 sparked a sudden drop in the US dollar and an inverse jump in risk assets everywhere. As shown below in our favourite US dollar chart, the US dollar index is now approaching near-term support again around 76 and we will soon see if it is able to bounce again off this trend line. If it does, we should see the next correction phase for stocks and commodities which are now heavily over-bought.
In 6 short weeks, the S&P has spiked from a year to date loss of 6% to a gain of almost 6%. Impressive. But also troubling for those trying to invest capital carefully. As we have seen many times the past decade, price moves based on stimulus injections, price manipulation and currency jolts have always been like dynamite: volatile, time-limited and full of risk.
As we have mentioned many times the past 18 months, the stock rally since the spring of 2009 has been on alarmingly anaemic volume. Traditionally, less participants and less buying pressure leave markets more vulnerable to downside pressure when selling spikes. The flash crash in May was a vivid example of 'surprise' moves that can materialize in these markets. The more over-stretched, over-bought and over-valued prices become, and the more heightened the price risk to capital invested.
So knowing that these periods have a history of ending badly for investors, one cannot help but wonder who has been buying this rally over the past 6 weeks?
We know that retail investors have been selling stocks and stock mutual funds month after month since January 2009. Individual investors, like consumers, seem focused on building cash savings and relative safety. Not too enamoured with the stock market for some reason…hum…interesting. So it’s not the retail crowd. We also know it is not mutual funds doing the buying as they have not been receiving net inflows from investors and were already fully invested coming into September (they almost always are) with cash rates at a cycle low of 3.5%.
So who is buying? The answer seems to be pension funds–suffering from huge funding holes and still desperately trying to double or nothing rather than admit their 8% return goal has been missed for 10 years and is actually reckless; hedge funds most of whom lost money over the past 3 years and are now desperately trying to catch up; and proprietary trading desks at financial institutions who are losing revenue in most of their business areas this year and are aggressively trying to goose profits for year end bonuses. As David Rosenberg points out this morning from the Federal Reserve data, bank-wide trading assets are up $50 billion in just the past month. Could it be that the banks, who run the Fed, had an inside scoop that more QE was being contemplated in Q4 as a feel-good run up to the November mid-term elections?
If pensions, hedge funds and bank trading desks had a record of wisdom, or lasting profits their buying the past 6 weeks might be somewhat reassuring to those of us worried about preserving capital in these markets. Sadly that is not largely the case. The supposed “smart money” has become increasingly desperate the past couple of years. This leaves the rest of us to navigate our capital through a world of wild wagers being made by throngs of the financially deaf, dumb and blind.
