Market Overview, September 2009

The greenback maybe down but is it out?

Through history, nations’ political power has been reflected in their currencies:

The Roman denarius was once the currency of an empire which stretched from the Atlantic to – briefly – the Caspian Sea.

Spanish pieces of eight were legal tender across the globe from the Americas to modern day Indonesia.

The reach of the pound sterling grew with the expansion of the British Empire, and then declined after the Empire’s collapse…

…and after World War II, America’s growing global dominance has been embodied by the dollar, but are the greenback’s days now numbered? Will other currencies come to take its place?

Why does this matter?

Essentially, commodities are an alternative to holding another currency.

Investors who are looking to play the economic recovery through commodities and emerging markets should proceed with caution. These are trades that rely on the maintenance of a zero interest policy in the US beyond the point at which it is clear that the economy is recovering.

They also assume that, despite a decade of boom and supply responses, there is still under-utilisation in Chinese manufacturing and supply shortage in global mining, shipping and steel industries. The Chinese and commodity “secular” growth stories will also eventually prove cyclical, so complementary investment strategies may prove sensible.

As the US economy leads a global economic recovery, the dollar – which is already undervalued on a purchasing power parity basis – should be much stronger. This will reduce the appeal of emerging markets and commodities.

A strong dollar will, however, be a positive for many of Europe’s exporters who have fought the headwind of a strengthening currency for a decade: particularly world leading consumer goods companies such as BMW, Daimler, LVMH, Electrolux and Nokia. In addition, these powerful brands have competitive advantages which are not easily lost through lower cost competition.

There was evidence of growth between April and June. Maybe not in the UK or the US, the countries at the centre of the financial maelstrom, but France, Germany and Japan all supposedly grew in the second quarter of 2009.

At the same time, the emerging economies – especially China – have bounced back to rapid levels of growth, far quicker than anyone expected at the start of the year.
The OECD’s latest estimate is for the G7 economies (USA, UK, France, Germany, Canada, Italy and Japan) to shrink by 3.7% in 2009. Back in June it thought the decline would be 4.1%.

Make no mistake: that would still make 2009 a pretty diabolical year. As the G20 finance ministers observed last weekend in London, the poorest countries will get the worst of it, and they are reliant on that quarrelsome bunch of politicians for their “automatic stabilisers”, in the form of a better resourced World Bank and IMF.

Your choices: The emerging-market investment window is closing, and the market will eventually catch on to alternative investment opportunities that exist in a zero interest economic environment.

Of course, it’s always safer to buy what others buy. Then constantly “rotate” in and out based on the animal spirits of the day – even if that means racking up wealth-draining transaction costs and risk missing out on the market’s best days and months.

But I probably don’t have to tell you that…