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@theMarket: Third-Quarter Earnings Reveal Two Economies

Bill Schmick

With one quarter of the companies in the S&P 500 already reporting, third quarter earnings have been a positive surprise. Eighty-six percent have exceeded earnings estimates and 67 percent have posted higher revenue numbers. What the numbers don't say is that most of those gains have come from overseas.

The revenue number is where we should focus our attention. Higher earnings can be achieved by simply continuing to cut costs (by firing workers, for example). However, looking at the revenue numbers gives us a clear understanding of where the growth is coming from. Not much of it is coming from the home front. A lot of that growth is coming from higher sales in Asia and other emerging markets.

Since the bottom of the recent recession here in America, the majority of firms in the S&P 500 have been exporting their way into profitability. This quarter was no different. Take United Parcel Services; it is one of the companies that investors consider a good barometer of the global economy because it delivers products everywhere. UPS showed a 3.5 percent increase in growth versus last year here at home while their international growth was 13.7 percent. Many other companies are experiencing the same phenomenon.

Clearly, the falling dollar has helped exports as has the increasing strength in emerging market economies, particularly in Asia. And this weekend all eyes will be focused on the latest round of G20 talks in Seoul, where the ongoing battle to "beggar they neighbor" will continue. We can expect currencies to be one of the main topics of conversation since our own U.S. Treasury Secretary Tim Geithner has already fired the first broadside. In an open letter he has asked members to "refrain from exchange rate policies designed to achieve competitive advantage by either weakening their currency or preventing appreciation of undervalued currency."

In last week's column, "The Coming Currency War," I explained how the world's governments are using their currencies to increase exports at the expense of their neighbors. Clearly, U.S. third-quarter earnings underscore how our own policies have aided and abetted U.S. companies in exporting more. This makes Secretary Geithner's request look a bit suspect in my opinion. It will be interesting to see the response of other governments.

I mentioned last week that I was waiting for commodities, specifically gold and silver, to pull back. I expected that pullback to be sharp, and it has been. After hitting a high of $1,380 an ounce, gold dropped as low as $1,317 an ounce in what felt like a blink of the eye. Silver also had a commensurate move downward. As expected, a rise in the dollar was the catalyst for that pullback. Traders will wait until they see the results of this weekend's G20 meet before going back into precious metals or other commodities.

There is always the risk that some new policy initiative could strengthen the dollar and thus continue the commodity sell-off. It could happen, but I wouldn't hold my breath. There are few new policy alternatives on the table in Washington to revive the economy so my bet is that after a brief period of strength, the dollar will resume its decline, gold and other commodities will continue higher and so will the stock market. Under that scenario, we are back to buying the dips. Invest accordingly.

Tags: currency, global economy, dollar      

The Independent Investor: Does Cash Mean Currencies?

Bill Schmick

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.

Tags: currency, dollar      
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