Watching the US Dollar

I was speaking to an investor in Dubai the other day and he clearly stated that his investments are for the long term. No interest in selling because of market turbulence. The US and other Western countries are known for focusing on the short-term. The real dilemma here is what happens when challenges that are considered long-term in nature all of the sudden impact today’s market and therefore the long-term outlook of your investment?

This appears to be what we are experiencing right now. If you talk to a market bull they usually point to strong corporate earnings especially those in the US and many Pacific Rim countries. Risk-taking should bounce back because of this which bodes well for stocks and the Euro. Looking at the US for example apparently 15% of the S&P 500 company revenue is derived from Europe. This is the minority of their revenue and even with a 15% depreciation in the Euro market bulls should be salivating at valuations right now. Bears seem to be salivating for another reason. They are the ones in command right now. Their calls for a correction were eventually correct and to them the question for the Euro and other securities is how low they will go.

The crash that occurred two weeks ago, or ‘flash crash’ as people are now calling it, has to remind those experienced enough of October 1987. Back then one-third of the Dow Jones value was wiped out in just a few trading sessions. Program trading was tainted as the cause and the bears claimed victory. Less than 2 years later though those losses were erased and the Dow Jones had regained its prior status above 2,700. Those that focused on the long-term ended up doing quite well.

How may have you seen that crash coming? Yes, it is easy to say in hindsight but have a look at the US Dollar. The monthly chart in USDCHF shows that this pair fell from a high of 2.84 in 1984 to 1.26 in 1987. USDJPY fell from 264 to 120 over that time. Talk about an impact on corporate earnings! By the time that October 1987 had come around the depreciation of the US Dollar was near the end. The damage had already been done. As we’ve discussed before not all the markets had priced this in. The US Dollar was certainly overvalued back then just as the Euro has been overvalued more recently.

Certainly the recent correction in USDCHF or USDJPY are not on the same magnitude as what we saw in the ‘80s but those focused on the long term may have seen this signal of turbulence in the markets. I’m sure today’s traders wish they were around for the volatility of ‘80s but there should be enough right now to trade with. The good news for short and long term investors alike is that the US Dollar will probably set the tone for the next upward trend in risk-taking before another correction occurs. If and when history repeats long term investors watching the currency markets will be prepared for the turbulence that follows.

This report is for your information only and does not constitute investment or business advice or an offer to buy or sell securities.

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