Sunday, November 4, 2007

Which way from here? Alice to the Cheshire Cat

The Cat only grinned when it saw Alice. It looked good-natured, she thought...'Cheshire Puss,' she began, rather timidly... `Would you tell me, please, which way I ought to go from here?' `That depends a good deal on where you want to get to,' said the Cat.
`I don't much care where--' said Alice.
`Then it doesn't matter which way you go,' said the Cat.
`--so long as I get somewhere,' Alice added as an explanation.
`Oh, you're sure to do that,' said the Cat, `if you only walk long enough.'
Alice felt that this could not be denied, so she tried another question. `What sort of people live about here?'
`In that direction,' the Cat said, waving its right paw round,
`lives a Hatter: and in that direction,' waving the other paw,
`lives a March Hare. Visit either you like: they're both mad.'
`But I don't want to go among mad people,' Alice remarked.
`Oh, you can't help that,' said the Cat: `we're all mad here.
`How do you know I'm mad?' said Alice.
`You must be,' said the Cat, `or you wouldn't have come here.'

Conor Sen works in the investment industry and is coauthor of "How Markets Really Work"
From Conor Sen:

"I was about to write that in a the least 'normal' economic system risky asset is cash parked in short term government paper or cash on deposit. Low risk and high liquidity also means that the return on cash tends to be lower than the returns on equities, bonds, and real estate. However, since I am no longer sure what 'normal' is, I decided to amend the above truism to 'in a balanced and non-inflationary economic system' cash is the safest asset. Clearly, this does no longer seem to be the case. Cash is losing its purchasing power -- it would seem -- at an accelerating rate against other assets because of the Fed's expansionary monetary policies."
During a deflationary period/economic downturn/credit contraction the natural response for most people is to sell longer-term and risky assets, cut back on consumption, and shift to short-term assets with high liquidity and low risk. The Fed knows this, so what they do is lower interest rates to create less incentive for this behavior. How safe is your money market account if its yield keeps falling, and if the value of the dollars in the account fall as well?
The sad answer is not very safe at all. The market, smarty pants that it is, is coming to the realization that the dollar is no longer going to be the world's currency. As liquidity in other assets has grown, they have become currencies of sorts as well. The dollar, the yen, the euro, gold, oil, FXI, GOOG, energy stocks -- they're all currencies now, and they're all appreciating and depreciating at different rates. The simple fact is there's no such thing as a safe haven anymore. Even those of us who love gold know that in the deflationary bust sure to come gold will decline with everything else (I must note, however, that when gold does deflate, it will represent the best investment opportunity that we are likely to see in our lifetime). In the short-term the safest assets in the world are the currencies that stand to benefit from the carry trade unwind, namely the yen and Swiss franc, plus the renminbi which is going to appreciate over the next 5-10 years and won't suffer in an economic bust.
In the meantime, the tug of war between the handful of assets still appreciating and the growing credit contraction forces continues. Watch gold, oil, FXI, BIDU, GOOG, AAPL, etc. If those deflate, run for the exits. We're in a blow off top that can last for a lot longer than people think, but the bust is coming.

No comments: