Are Capital Markets Telling Us Something?

Well, probably.

I have been writing for months (mostly on my other site, that doesn't have much of an archive) that action in markets seem to be building in some unpleasantness for US equities. I first noted flattening action in US Treasuries in the spring, back then it was a more benign maturing of the economic cycle. I now view the extreme move higher, in price, of the ten year to be a swift path to recession if the yields keep moving lower.

The strength in gold represents a capital flight of sorts. In the last few months gold has moved from $380 to almost $430. A portion of that move can be attributed to dollar weakness, but I believe heightened concern about the next few months accounts for most the move. Still we must factor in traditional seasonal demand this time of year from China and India.

You have probably read more than you care to about oil's move up. My spin on the issue is that it is more demand driven than most analysts assume it to be. There is nothing new about conflict in the middle east, hurricanes in the southeast, or labor issues anywhere else in world. It is not intuitive to me that this list of things could account for a doubling in the price. I also don't care for the term terror premium. It implies a short term lift due to mid-east violence. That only makes sense if you expect fighting to cease in 3-6 months. I don't, do you?

The newish thing is the accelerated decline in the dollar over the last few days. We are at multi-month lows vs. the Yen and the Euro. We are at a nine year low vs. the Swiss franc. The dollar is sliding dramatically vs. the commodity currencies, Australia, New Zealand and Canada. We may see this action spill into the Korean won, Sing dollar and Philippine peso as well.

This trend is due in part to the deficit issue, President Bush's lack of popularity outside the US, lingering questions about the US economy and other things.

I continue to be worried about all of these things and I don't see much going on to alter the direction of these trends.

On top of all that we can not do anything to screw up foreign demand four our Treasuries. I have written about this several times before. It could be several years before either candidate can begin to reduce the deficit That means Japan, China, India, Taiwan and others all need to keep buying US debt so we can pay our bills. If demand dries up, rates will move higher and higher until demand comes back.

How do you invest into this environment? I believe it makes sense to overweight foreign, low beta, dividend paying stocks. I still maintain exposure to all sectors in the US market, but underweighted. To capture some volatility I own secondary tech names and about 2% in emerging markets. I believe the high beta I own could gain 50% in a year. If that works out it would add a couple of hundred basis points to the portfolio's return. If I have chosen the wrong names and they cut in half, the loss would be off set by dividend throughout the portfolio. I should also mention I have allocated quite a bit to cash over the last few months. I will keep you up to date on any changes I make.