Friday, November 20, 2009

A neglected asset class?

In an exchange with Aaron Edelheit on his blog earlier this week (in the comment thread of this post of his, "Why are you sitting in cash?"), I pointed out that, even if one were bearish on the U.S. dollar, it might not make sense to diversify out of it now if one believes that the stock market is overvalued. That's because, if history is a guide, the dollar will rally (at least temporarily) when the stock market corrects. At that point, after the dollar rally, it might make more sense to diversify into non dollar-denominated assets.

Richard Bernstein made a similar point in his column in yesterday's Financial Times ("Lessons of investing are ignored"), noting the negative correlation of U.S. Treasuries to stocks and other asset classes:

Investors should be trying to emulate their Chinese and Japanese overweight positions in Treasuries. Instead, Wall Street is striving to get the Chinese and Japanese to “diversify” like everyone else. In my opinion, the Chinese and Japanese should ignore the advice and stick with their Treasuries.


Treasuries are today’s “alternative” asset class. Treasuries’ returns continue to be negatively correlated to equities, yet they remain widely underowned because investors consider them overly risky.

Update: Yahoo! Finance's current headline: "Stocks fall for 3rd day as dollar strengthens".


Anonymous said...


Maybe, but it's more expensive than it's ever been in our country's history and there are more available than ever. You'd think something neglected would be cheap!

Homer315 said...

Isn't the problem though that perhaps the dollar may drop considerably going forward before there is a correction which makes it rally? That is to say, what if the dollar falls 15-20% in the next six months to a year, and then only rallies nominally? You'd have been better off getting out now then after the rally if it's still below today's levels. I think therein lies the problem with these types of macro forecasts...

DaveinHackensack said...

That's possible, Homer, but I don't think it's likely. I think the fundamentals of the U.S. economy in particular are pretty lousy, and as last year showed, there is still a fairly high correlation between our stock market and markets overseas. I think it's more likely that we'll have a stock market correction in the next 6-12 months, and that the downside risks to stocks over that time period are greater than the downside risks to the dollar.

DaveinHackensack said...

Bloomberg TV just played a clip of Nobel Laureate economist Robert Mundel who said he believes the dollar is close to bottoming, if it hasn't already. He also predicts a double dip recession when they tax cuts expire next year.

Nick Rowe said...

Dave, I agree with you entirely. Stocks are way overvalued - propped up by artificial means by government. I wagered there would be a one-day 500 point correction in the DOW by year end and lost, but I still believe it's coming.

I pulled most of my money out of stocks, especially financials. They are going to get hammered by CRE this year. Fixed income funds will do ok as long as interest rates remain low, but how long can that last?

401(k)s give so little latitude on investment. I can't find any place to shelter my money. I can't even invest in TIPS.

I believe in (mostly) efficient markets and don't believe anyone can be an effective market timer in the short-run. Obviously, I believe one can identify bullish or bearish situations and invest accordingly in general terms. In the long run I'm bullish on stocks, but I'm not going near the market this year. I'd rather miss out on some gains than risk the correction I think you and I are anticipating.

This low-interest rate regime and government spending is simply creating more asset bubbles in housing and the stock market in a search for yield.

I'm on the market to buy a house in San Francisco. I'm seeing the same market conditions I saw in 2003, except without the subprime loans. When you bid $25K over asking price and are outbid another $25K by a cash buyer on a mediocre house, there is something amiss.

DaveinHackensack said...


Then why not consider shorting some stocks, or buying puts on them? I even know of a site where you can find potential candidates to short (Short Screen).

Nick Rowe said...

That's great advice but I have some financial constraints. I can't short sell or trade options with my retirement portfolio. At best I might find a hedge fund among available portfolios. All my cash is desperately seeking a house.

The problem is with the 401(k) which gives limited investment options.