When I was in high school, one of the machine shop courses I took was in a room we called “The Belt Jungle”. There were large motors suspended from the ceiling which powered shafts lined with pullies, each of which powered a machine tool by means of a wide leather belt. To start your machine, you first activated a clutch, as not doing so would cause the gears to violently grind and likely damage the tool. I was working on a large engine lathe and, as kids will do, I threw it “into gear” without first using the clutch. There was a load bang and the sounds of gear teeth falling to the bottom of the gearbox.
When looking at what’s happening in the market, we are faced, not with sand being thrown into the gears, but at least gravel and potentially throwing them into gear without using the clutch.
People here are used to questioning how many angels dance of the head of a pin in order to evaluate the true value of a share of Berkshire Hathaway and tacitly admitting that “the dollar is under pressure” without evaluating it quantitatively. Since the end of January when the US Dollar Index (DXY on Marketwatch) was about 110, it has dropped to about 98 – which means that your US dollar holdings’ value now has about 10% less global purchasing power when compared to a basket of other currencies. Simplistically, you are now 10% poorer than you were a couple of months ago.
During January, gold rose from $2,600 an ounce to its current $3,400 an ounce – a rise of over 30%. While gold might (or might not be) a hedge against inflation, a move of this size indicates fear about the precipitous loss of value of a currency (the last time we saw anything like this was during the Great Recession).
Add that to the somewhat wonky behavior of the bond and you have a series of paradoxes.
A lower US dollar is, in theory, positive for the US equity market. It favors multinational corporations reporting profits in stronger currencies in terms of relatively weak US dollars. It should also make US manufactured goods and services more desirable to other countries.
So, what went wrong? The REASON for the decline in the USD trumps the theoretical long term potential benefits.
Picture a bunch of school kids who theoretically “should know this stuff” help their dad retune their audio system because the sound “isn’t quite right” (because it was set up to the preferences of his newly estranged spouse) by giving a blizzard of simultaneous conflicting and questionable advice. This causes nearly every knob and switch to have their position changed. This causes the sound to become obviously worse, but none of the kids are willing to apologize for their ignorance and their father, proud of their precociousness, keeps praising their results – despite the fact that the changes made risk blowing out the amplifiers. And, of course, no one thought to write down all of the original settings and how they interacted, so they have possibly reached the path of no return.
It reminds me of a story I heard about a doctor who specialized in treating rare tropical skin diseases. One day, he looks in the mirror and there is a large pulsating purplish growth eating his face. His comment was “You know, on me, it looks good”.
Jeff