August 9, 2011

Follow the Cash

Headline at 2:34 p.m. Eastern Time today: “Fed Pledges Low Rates Through 2013.”

How many recognize this as a currency-devaluation? Markets jumped 4% here in the U.S. as the DXY, the dollar index, dropped.

Last Sunday, the European Central Bank pledged to monetize debts of Italy and Spain. Monday, markets plunged globally. That’s a currency-devaluation. The central bank is promising to increase the supply of currency without a corresponding increase in economic output.

Most blamed S&P’s downgrade of US debt. But the dollar strengthened, and Treasurys increased in value. Why would the diminished instruments be more valuable?

Because that’s not what caused markets to tank.

Last Wednesday the central banks of Japan and Switzerland devalued their currencies. Thursday, August 4, markets plunged. Many blamed debt talks. How, pray tell? That’s an assumption without buttressing facts.

By contrast, we have three profound examples inside one week of the global relationship between currencies. As we noted last week, currency trading volume is over $4 trillion daily. US equities are $100 billion or so, on average.

The tail is wagging the dog. Following the cash – the only commodity that is increasing by leaps and bounds upon the planet – leads us directly to the cause.

Why do stocks move inversely with the US dollar? The currency that is supposed to reflect the valuable exchange of goods and services is instead being used to compensate for the absence of valuable exchange. When things go up and down relative to denominating currencies rather than intrinsic worth, it’s difficult for anyone to assign proper values to securities.

Why should you care in the IR chair? It’s an object lesson. If you measure your success by the way rational money responds, you are on a bridge to nowhere. We’re seeing rational investment activity plunging yet again. How can investors buy your stock when its value is often controlled by the ying and yang of the yen? Or the dollar. In one major technology company today, the percentage of rational investment activity dipped to 8% of volume. So 92% of its trading is driven by something or somebody else? Yup.

We suggest setting ranges for the amount of program trading, speculation and rational investment in your volume – so you’re measuring overall trading health rather than investment activity. Because unless all of us call for fixed rates of currency exchange so stocks have value driven by business worth rather than European bailouts, it’s not going to change soon.

Assessing what we know about data, it’s logical to think that US equities will continue to appreciate now into options expirations next week. If currencies are leveling out again on all this intervention, money flows to relative value. But with expirations, the relative value might reside somewhere else.

I don’t know about you, but to me this seems…unhealthy.

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