ETF Expert

Speak to an economic optimist and the conversation might include: (a) Dominance in U.S. technological innovation, (b) Forecasts for economic growth that are better than Japan or Europe, (c) Leaner companies beating expectations, (d) Corporations merging or acquiring (M&A), and (e) America has always bounced back. The optimist might sum up with the idea that the credit collapse didn’t kill us… so it can only make us stronger.

The economic pessimist has a completely different perspective, including, (a) Companies have no intention of hiring back, (b) Inflation already exists… lower purchasing power/higher prices are the inevitable result down the road, (c) Real estate will remain depressed for 5-10 more years, (d) The U.S. may never be able to get out of its own deficit death spiral, and (e) The “new normal” means scaled-back consumption in ways not seen since the 1930s.  Translation? GDP won’t tell the true tale of a long-term decline in the standard of living.

Yet when have economic realities, or even economic perceptions, been the primary drivers of investment markets? What does it mean to have P/E ratios that can be 30, 20, 15, or 10… and analysts still argue about overvalued and undervalued? When stocks lost half of their value from 10/1/2007-3/1/2009, did this represent economic reality? Conversely, if the Dow goes from 6500 to 10,000 in 6 months, have economic prospects really improved by bounds and leaps?

Markets move on fear and greed. Markets also move on technical price trends. They can move on manipulation… and they can move on leverage a la the “U.S. dollar carry trade.”

For instance, anyone that watched oil go from $75 to $150 in less than 6 months understood that worldwide demand didn’t just pole-vault 100% in a half-year, nor did economic demand suddenly decline 75% when it dropped to $33 per barrel over the next 6 months. For that matter, demand didn’t just jump 100%+ yet again this year as we moved back to the $66+ per barrel range by the summertime.

This is not to say that economics don’t play a role in market direction. Yet is it actual earnings or psychological guidance? Is it true supply and demand or is it irrational exuberance (pessimism)?

The way that I see it, different things matter at different times. Yet more often than not, you’ll find a certain theme take over the entirety of the marketplace for a particular period. Interest rates, oil, inflation, deflation, earnings… or possibly, fear or greed related to those very topics.

Right now, most of what you hear in the marketplace about economic growth or economic stagnation is noise. The single largest factor in market direction at this moment is the  U.S. dollar carry trade.  (Note: Click on the link to see some of the ETF winners of the carry trade.)

Simply stated, investors around the world have little to no fear that the dollar will dramatically rise. They can borrow dollars at negligible interest rates and invest in currencies with higher interest rates or global stocks with dividend yield or appreciation potential. There’s even widespread expectation that the dollar will continue to weaken, making global stocks and alternative currencies doubly attractive.

If the dollar waffles or stabilizes or trends lower slowly, stocks should continue their upward ascent. Every asset from Vanguard Emerging Markets (VWO) and Vanguard Total U.S. Stock (VTI) could be expected to perform.

However, what if the dollar does strengthen? Not just a little… but what if it were to climb ferociously? Maybe the Fed changes direction and aggressively raises rates, or maybe major hedge funds all go long on the dollar at the same time… creating a self-fulfilling prophecy.

Keep an eye on the all-important PowerShares Dollar Bullish Fund (UUP). If UUP climbs above a 200-day trendline long enough to garner support… global economic recovery “talk” will be overwritten by fear-induced profit-taking/liquidation. (It’s not a likelihood in the near-term, but it’s a worthwhile indicator of trouble.)

If you’d like to learn more about ETF investing… then tune into “In the Money With Gary Gordon.” You can listen to the show “LIVE”, via podcast or on your iPod.

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