The problem with fundamentals

For the last five years, while the boom in commodities raged on, we told ourselves that supply simply couldn't keep up with demand. Words like "BRIC" and "Chindia" were thrown around boardrooms and dinner parties. Smooth-talking analysts spoke assuredly in conference calls about the super-cycle, decoupling of Asia from the West. 

Decoupled? As Time Price wrote in a recent letter, "...its [China's] stock market hasn't exactly couple, more like entered a suicide pact."

Fundamentals have become increasingly subjective, as is their want in times of volatility and bear market conditions. Most investors are net buyers, bulls at heart, leaving the short side open mainly to professionals. As a result they are either in and holding losing positions, convinced that they are "fundamentally" sound, or they are out of markets, often in cash and overtly bearish. Fundamentals fall victim to sentiment. Fundamentals are a dangerous thing in bull market conditions, the same logic can also deepen losses when the market turns.

Ask an investor like Buffett about fundamentals and he won't give you a story about the growth of the middle class in China or urbanisation. He will talk about cash flow, conservative gearing, yield, dividend coverage. A blue sky uranium miner talking about power shortages and the potential for new nuclear power stations in China and India, whilst dressing these projections up as fundamentals, is still just blue sky.

If you have to be in the market be sure that you are looking at a potential three year pay-off for investments made now. With further potential for fiat currencies to weaken, gold (despite its lack of utility) is surely a safe bet in the same time frame. Property, especially the UK, has to come off at least 25% or stay stagnant for years to become affordability.

Tread carefully and beware the broker on the phone talking about fundamentals.

How long can the USD strength last?

In the Short run, you have to go with the momentum trade - the tailwinds are behind the USD as the EUR and GBP battle significant problems. The USD seems suddenly to be in better shape, perhaps because most of the bad news is out or maybe due to the opacity of the European economy. The pound looks to be badly hampered for 18 months at least as the property market corrects savagely and financial services suffer.

Over the next 24 months who would back the USD? Surely sovereign funds and those countries holding huge USD reserves (China, Taiwan etc.) would be looking to diversify their currency risk somewhat. Also, with real interest rates in the US in the negative, the holders of US Treasuries are getting a battering in real terms.

Commodity backed currencies fall prey to unexpectred USD strength

Perhaps on the Brazilian Real stands out as a the "least worst" performer against the USD. With the air deflating from the BRIC balloon, it might be the hardest hit if we see further USD strength. The greenback is in high demand as the eurozone looks headed for recession - the impression is that most of the bad news is out on the US economy.

This USD strength is very confusing, given recent consumer prices and jobless claims data. It seems unlikely that the Fed will head into a tightening monetary policy in a rush, but it is certainly ahead of the ECB in this regard. The Bank of England has a world of worry - the pound is no longer sound.

Bear trap or not?

We're all pondering this one at the moment. Most with the full knowledge that the credit deadlock is unlikely to lift in a hurry, that the US still hasn't seen the end of its housing crisis, and the UK is yet to see the worst of its housing collapse.

It is even harder to make heads or tails of the current dollar strength. Some suggest it is a flow out of the euro due to Russia's meddling in Georgia and the failure of EU finance ministers to cooperate efficiently in the eurozone. It is quite amusing to think that the US dollar might be increasingly looked upon as a safe-haven currency. Certainly not good news of those who through exports boosted by a weak dollar might save the US economy. Something to consider for dollar bulls, aside from the growing consensus that the rally is overdone from the herd of sheep that are banking analysts, is the negative real interest rate. US$ holders are still getting a negative real return on their money when one considers rates minus CPI:


Furthermore, it seems unlikely for the DOW to continue to rally if real rates remain negative. However, the collapse of commodity prices bodes well for real rates staging a turn-around. I still believe that oil will reassert itself above $125bbl when the world again realises the structural problems of increasing demand and a decreasing rate of supply growth.

If you have to be in the market, consider this fundamental and unimpeachable macro fact - the western world is ageing. Look to the battered biotechs.