Good Evening: Just when it looked as if the U.S. stock market would resume the Friday/Monday slide today, share prices pulled out of a morning nosedive to finish higher for a second straight session. Rising energy prices and a falling dollar both aided this light volume turnaround, with the latter receiving quite a bit of attention from luminaries located in Omaha, NE, and Newport Beach, CA. Since so many investors have previously used dollar weakness as a signal to expand their risk appetites, the warnings about the greenback from points far west of Wall Street should make for an interesting next few days.
The big news overnight was not Hewlett-Packard’s earnings (HPQ reported a beat, but its shares declined, anyway), but renewed pressure on Chinese stocks. The CSI 300 index lost nearly 5%, bringing the cumulative damage since its recent peak to 20%. With little in the way of economic data out today, the thud felt in China had an impact on other markets. U.S. stock index futures were thus indicating a 1% lower opening prior to the commencement of trading in New York. Better earnings, but only so-so guidance from Deere (- 3%) didn’t help the psychological backdrop, either.
Once stocks did open just more than 1% lower, though, the selling just dried up. Already on a bounce that would carry them back to nearly the unchanged mark, the major averages (especially the energy sensitive companies inside them) turned positive after the energy inventory data were released. Rather than the expected builds, inventories dropped and sent crude, its products, and commodities in general on a bit of a tear. Energy and raw materials names led the resulting upswing that left most of the indexes up 1% by mid day. Trading then slowed and the averages gave a little ground into the close. The Dow Transports (+0.3%) were the smallest beneficiary of today’s rally, while the Russell 2000 (+0.95%) was the best performer. In a mild upset that may or may not mean anything, Treasurys bucked the mild trend toward expanding risk appetites by rising. Yields fell 4 to 7 bps as the yield curve flattened. The dollar, however, did line up with equities when it fell 0.6%. Commodities followed energy prices higher, and the CRB index led all the other asset classes in gaining 1.6% on Wednesday.
Whereas equities have enjoyed a positive correlation to commodities and a negative correlation to Treasurys, the strongest relationship this summer has been the inverse one between stocks and the U.S. dollar. When one rises, the other falls, and vice versa. Today, one of the factors that may have inadvertently helped push equities higher was a couple of negative articles about the greenback. First, Warren Buffett took issue with what he called “greenback emissions” in the Op Ed piece for the New York Times that you will find below. The Oracle of Omaha is concerned about all the deficit spending, money printing, and the resulting surplus of dollars in the global marketplace. He plays it down the middle, careful not to blame either major party, and he actually praises both the Bush and Obama administrations for their actions during the Great Recession. But even the eternal optimist in Mr. Buffett can’t ignore what he feels is a long term threat to the U.S. — currency debasement and, ultimately, inflation.
PIMCO also piled on with its own warning about the perils of endangering the dollar’s status as the global reserve currency of choice (see below). What was interesting about the reaction in our capital markets is that market participants took the weakness in the greenback as a signal to buy stocks today. Perhaps the sense of bullish capitulation described in the Bloomberg article below is another reason large investors have been chasing stocks since March. The momentum crowd that tends to rule the short term direction in stock trading didn’t seem to catch Mr. Buffett’s strong hint that, left unchecked, the massive fiscal and monetary responses sponsored by Uncle Sam to date will someday risk a return of inflation, a funding crisis, or both. Mr. Buffett even quotes John Maynard Keynes, the patron saint of Congressional economics, when describing the risks of letting the politicians in D.C. decide whether to make tough decisions when it comes to economic matters:
“‘By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens…The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.'” (Source: The Greenback Effect).
Mr. Buffett unfortunately ignores the important role the Fed plays in this process, concluding that “Unchecked greenback emissions will certainly cause the purchasing power of currency to melt. The dollar’s destiny lies with Congress” (source: The Greenback Effect). If we have to rely on the U.S. Congress to do the right thing, then I fear Mr. Keynes will ultimately be proven right with regard to his above analysis. Bill Fleckenstein, who penned an excellent review of Mr. Buffett’s NYT piece today in his Daily Rap (www.fleckensteincapital.com), has long since reached the Keynesian conclusion about politicians and their love of inflation to cover up their sins. The masthead on his website has long read: “In a social democracy with a fiat currency, all roads lead to inflation.” Well said, Bill. Mr. Market, please copy!
— Jack McHugh