Beware Ill winds from Currencies

The global business and capital market cycles are at a delicate point. They have been in decline, appear now mixed and with potential for a new cycle from late 2009. The recent focus has been upon decline in junk bond yields and recovery of equity prices. We would be beware that ill winds from currencies (the largest traders at $3 trillion/day) could have tremendous disruption if U.S. dollar (now 1.42/Euro and 95 yen) weakness were to continue. Despite the Swiss National Bank, the Bank of Canada and others, the dollar has also recently run down against smaller currencies. Unlike transition from Sterling to a U.S. dollar era early in the 20th century, we see no eagerness for change in the global measure of exchange by faster growing areas like China. We maintain that not just economic growth but issues like military/political prowess and capital market depth play roles. Even as fixed income rates in Europe and North America converge, the major OECD countries are engaged in massive debt finance for which currency volatility would be disruptive. The smaller freely trading currencies collectively are probably too small to counteract systemic risk.

In global earnings reporting started with U.S. companies, the crucial period is current, with numerous European and Asian companies joining the fray. Across a wide array, our observations of bifurcation and revenue stress remain intact as do still weak earnings, notwithstanding market relief about earnings matching dramatically lowered consensus. In the real world despite chatter about translation advantages/duress, the business reality before has been that currency volatility has thrown up unforeseen upsets to earnings (more volatile than revenues), not least amongst sophisticated capital market participants like financials and multinationals. As such and at this stage of global cycles, especially another precipitous 5-10% decline in dollar exchange rates could bring more disruptive volatilities. We would emphasize stability for quality of earnings and for our quality oriented scenario. As a hedge, we maintain gold bullion exposure in our overall asset mix, notwithstanding bullion close to $957 /oz

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