When the financial markets experience a strong trend, investors tend to pass through five distinct emotional stages:
- Denial. The trend isn't real. Or it's nothing an intelligent investor would put a dollar in.
- Skepticism. OK, there may be something there, but it's too risky.
- Bargaining. The trend is real. I'll invest, but only if the price is right.
- Regret. God, I've missed it. The time to get in was three months ago.
- Panic. This trend will go on forever. The risks were overstated. I've got to buy in.
We're now moving to Stage 5 in the so-called collapse of the U.S. dollar, which means this trend is actually nearing an end. That doesn't mean it's going to end overnight. Trends always run to excess and beyond. It does mean we're getting to the point where the easy profits are gone and that the risk is starting to rise.
And if you've been investing for a while, your portfolio has the wounds that show how dangerous it is to buy into a trend when everybody believes they must get in. (The smartest money is usually headed to the door at just about that point.)
It's not necessarily time to abandon a trend when it reaches Stage 5, but it is time to start trimming rather than pouring in money. And it's a time to think very, very carefully about what stocks and other vehicles you use to ride the last stages of this trend.
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How far the dollar has fallen
The dollar is down about 9% against the euro since January and about 11% against a trade-weighted basket of currencies.And the damage is even worse against what I'd call the world's commodity currencies. So, for example, the dollar is down about 16% in 2009 against the Canadian dollar, 24% against the Australian dollar and 27% against the Brazilian real.
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There are good reasons for the decline:
- The U.S. consumer is in a deep, deep hole. Households owed 127% of disposable annual income at the end of 2008, according to the Federal Reserve. To get that ratio down to 91%, the average from 1990 to 2000, households would have to shed $4.4 trillion in debt.
- Government debt has soared during the financial crisis, and the federal budget wasn't in great shape to begin with, given huge unfunded liabilities in health care and retirement programs. The percentage of federal debt held by the public is projected to go from 41% of the gross domestic product in 2008 to 68% by 2019.
- The U.S. has been slower coming out of the economic slowdown than China, India, Brazil, Australia, France, Germany . . . well, the list goes on and on. Interest rates in many of those countries are already higher than in the United States, and in some -- Australia, for example -- central banks have already started to increase interest rates.
When a currency goes into a fall like the dollar's recent plunge, the trend starts to feed on itself. The dollar goes down (or just threatens to go down), and no one wants to risk owning dollars, which makes the dollar sink further, which makes fewer people want to own dollars.
And it takes a pretty big shock to reverse this kind of self-reinforcing move. In an Oct. 14 post on JubakPicks.com, I laid out the case that the downward trend for the U.S. dollar will continue until sometime around mid-2010, when the Federal Reserve makes it clear that it is on course to start increasing short-term U.S. interest rates from today's level near 0.25%.
Continued: How much more can it fall?
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