The Independent Investor: Does Cash Mean Currencies?
There was a time when one of the rules of asset allocation was to always keep a little cash in your portfolio. Cash was the safest bet you could make. It became the place where we retreated when the markets were in free fall. Today, however, cash as an asset class, earns almost nothing. As a result, many individual investors are using that cash to trade currencies and in the process transform the world’s safest investment into something a lot more speculative.
The headline on the front page of Wednesday's Wall Street Journal read "Currency Trading Soars." The article explained that buying and selling currencies has become a $4 trillion a day market. How much of that volume is attributable to individual investors is hard to measure but from my own experience I can tell you that investing in currencies has never been easier or cheaper. Thanks to exchange traded funds (ETFs), the average Joe has his pick of 44 currency funds that are as easy to buy and sell as individual stocks.
Here in America, where since World War II we have been accustomed to having one of the world's strongest currencies, the desire to invest in other country's currencies has not been high on the list of investment priorities. The currency markets were something that banks used to square up their overseas borrowing or to provide you the necessary currency for your vacation to Hong Kong or Spain. It has only been in the last few years that Americans have begun paying attention to the dollar and its overseas purchasing power.
In other countries, where the fluctuations in the value of their currency can mean the difference between a secure future and poverty, trading in and out of currencies has been a way of life and a traditional avenue of investment. With the introduction of internet trading, ETFs and around-the-clock trading, retail investors in places like Japan, China and throughout the Middle East make a career of day trading currencies.
Clearly currencies markets offer the investor more depth. The currency market, at $4 trillion per day, dwarfs the trading in stocks which is only $130-$140 billion per month. The bond market is much larger and averages $456 billion/day but is still less than half the size of the currency markets.
"The stock markets are totally manipulated by a handful of big players. Bonds provide me less than the rate of inflation. Currencies, on the other hand, can make me a lot of money if I’m on the right side of a trade," argues one retired, ex-Fortune 500 executive who trades currencies by buying and selling ETFs.
During this summer he shorted the dollar (bought an inverse U.S. dollar ETF) and went long the Yen (bought a Japanese currency ETF).
"I made more money in currencies than I made in stocks since April," he crowed.
Although I congratulated him on his investment prowess, I also warned him that he was swimming with the whales in currency markets. Banks, hedge funds and mutual fund currency departments with trillions to throw around can outgun him money-wise, volume-wise and information-wise. These boys also have 24 hour trading departments. If the Japanese government were to suddenly intervene in their currency market, sending the yen dramatically lower (and the dollar higher), my friend could easily wake up tomorrow morning to a sizable loss before he could do anything about it.
This summer's collapse in the Euro was largely triggered by hedge funds. Riding the hedgies coattails works but only until it doesn't. The retail investor was the last to know when those big dogs reversed that trade. My advice to the majority of investors is to keep your cash in a money market and not try to speculate with it in the currency markets.
A better bet would be to buy a country fund or ETF if you believed the prospects of the country were better than most. That way, if you are right, you get a double win both on the country's currency and on its stock market.
@theMarket: Economy Sputters, Stocks Stutter
The markets were so oversold by Friday that even a hint of positive news was enough to send stocks higher. The trigger was the revision downward of the nation's gross domestic product to 1.6 percent for the second quarter. The initial GDP reading had been 2.4 percent.
"Why is that good news?" asked a perplexed client from Long Island.
"The revision could have been worse," I explained.
Federal Reserve Chief Ben Bernanke also helped push stocks higher by throwing the market a few straws of reassurance. He said he would consider another large scale investment in the markets if the economy deteriorated further or if deflation became a problem. At the same time, he said it might not be necessary because he still sees the economy growing next year.
The Fed has three options to further add liquidity to the system. They could buy more government bonds and possibly mortgage backed securities and drive mortgage rates even lower than they are now. A 30-year, fixed rate mortgage is now below 4.5 percent. In this atmosphere of uncertainty, they could further clarify exactly how long they expect to keep interest rates near zero. To date, they have only said rates would be low for an "extended period."
Finally, they could cut to zero the interest rates the Fed pays banks to park their reserves at the Fed. Right now they are paying 0.25 percent. That might seem a nominal sum to most, but when you have billions of dollars sitting there, that quarter of a percent adds up. This last option, I believe, is the key to getting out of the liquidity trap we find ourselves in.
For the last year and a half, the Federal Reserve has been dumping mountains of money into the financial system, hoping that the banks and corporations will in turn lend it to consumers and use it to hire workers, build new plants and buy equipment. Instead, financial institutions have been hoarding the cash and getting paid by the Fed to do so.
Why? Given the uncertainty of the recovery, the high unemployment rate and the risk of even more bad debts coming through the door, the banks believe it is better to keep the cash then risk losing it on future bad loans or, in the case of corporations, on hiring workers that they won't need in a double-dip recession. Fear is the name of that game.
"Play it safe, after all," they say, "a 0.25 percent return is better than no return at all."
This monumental timidity in the face of 9.5 percent unemployment and a housing market that is tipping precariously back into a downward spiral should be unacceptable to all of us. So how do we get the banks to lend again?
Simple, instead of reducing the rate the Fed is paying to zero, make it minus 1 percent or 2 percent. That's right; in order to park your cash at the Fed instead of lending it out, it's going to cost you. I believe faced with losing 1 to 2 percent on their money or risking it by lending to you and I at 5 to 6 percent, fear will turn to greed. This good ole American financial system will begin to work for us again instead of against us.
In the meantime, we are bouncing around the 1,050 level on the S&P 500 Index. I still maintain that 950 is in the cards. It's simply a matter of time before that occurs. I know this five-month trading range is frustrating to investors but patience will be rewarded, possibly as soon as September. The doom and gloom is building but has not yet built to a crescendo. We may well get another bounce this coming week but once again it will be on low volume and will simply be another bear trap, so don't be fooled.
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