Every now and then, the markets leave you speechless. This was one of those weeks. There was hardly any place to hide except for Treasuries and a rather choppy Gold in an ongoing flight to safety. So is there really a place to hide? Despite the U.S. credit ratings downgrade by S&P, the markets still believe, at least until market close on Friday, that U.S. Treasuries are the safest bet among increasingly fewer choices.
In terms of equities, a lot of this week’s volatility had to do with technical trading factors. When the S&P 500 fell through an important technical support at 1250, a level which everyone seemed to agree upon, sell orders were triggered and the markets headed South all the way to 1163 for the S&P 500.
From our perspective, the stock market sell-off is a concern. However, the larger issues are looming over the fate of the U.S. status as the largest, safest and most liquid capital markets. If the value of the Dollar continues to erode, any nominal returns in U.S. stocks will be eroded by returns measured in other currencies or other hard assets such as precious metals.
In the early 70’s it took over 4 Swiss Francs to buy 1 US Dollar. Today, it takes less than 80 Swiss cents to buy 1 Dollar. At the same time, the yields on U.S. Treasuries are near historic lows, alarmingly close to the lowest yields we witnessed during the financial crisis. For now, there is no visible change in trend. U.S. Treasuries continue to stay within the long-term trend of super-low interest rates while the value of the Dollar against some other hard currencies continues to erode. It does however beg the question as to how much longer we can play this game of charades i.e. convince the world that this is the safest place to invest and, while incurring yet more debt, offering increasingly lower real returns. This logic has defied me for some time now; it eventually defied Standard & Poors as well. Perhaps the historic downgrade from AAA to AA+ is another symptom of what has often been called the “new normal.” Perhaps reason will continue to take an extended holiday and real rates will continue to erode. A long time ago, someone said: “Hard to see the future is, the dark side clouds everything…”
While we cannot predict the future, we do know that the markets will continue to play out numerous scenarios in an increasingly complex and highly leveraged game of charades. Buckle up!