KRUGER INSIGHTS MONDAY, OCTOBER 14, 2013

By: Joel Kruger

THE PERMANENT CRUTCH – Market participants have come to rely on the fact that no matter how dire any situation may be, governments will now always be there to make sure that there is a fix. We live in a new world where there is no such thing as setbacks with any meaningful impact, and no such thing as consequences with material harm. At the onset of the global crisis back in 2008, it was clear that there would need to be some form of exceptional response from governments and central banks in order to avert catastrophe. Yet, somehow, this exceptional response has become the norm, and investors have grown to not only rely on this fact but demand it. Case in point  - Friday’s close in the US stock market. Though there was no resolution in Washington heading into a long weekend, stocks still managed to close out the day at the highs and also at the highest levels over the past several days.

MISSING THE POINT – The primary explanation for this price action was the very clear expectation from markets that a deal would be done over the weekend. Another explanation could very well be attributed to the round of dovish Fed speak into the end of the week, with various Fed officials confirming the right decision in holding back from tapering at the latest Fed meeting. But there is something so fundamentally backwards with both of these explanations. The first is backwards because it is simply unacceptable at this point in time that the market should be so certain of the outcome in Washington. There are some very deep issues being debated at the moment, and to expect that everything will be ok because that is they way things have been is unpalatable. The second is backwards because dovish Fed speak is dovish for a reason, and that reason is not a good thing. So for risk assets to rally because the economy still needs historic monetary policy accommodation 5 years after the crisis is also mind boggling. While it is true that Fed policy has incentivized and fueled this artificial rally to record highs in US equities, it is also now true that Fed policy is finally fully extended.

DON’T DISMISS THE BUCK – So with nothing left in the tank and the US economy still not back in tip top shape, what now? Well, I believe certain realties are finally about to set in, and these realities should translate into a serious bout of liquidation in risk assets. I have been positioned this way over the past few months, and during this time, we have largely seen a sideways market. But I understand that reversals like these can take time to play out, and I sit back and wait patiently with my short risk portfolio. A word of caution – Lately we have been seeing USD weakness on negative developments in Washington. The market seems to be interpreting any risks associated with a prolonged US government shutdown or US default as a risk on the US Dollar. I do not believe this is a correlation that will hold up over the medium-term, and instead would favor buying the buck on such an escalation due to the Greenback’s status as the world’s reserve currency and preeminent flight to safety play. Bad news in the US means worse news abroad, and if we in fact did see any extended government shutdown or threat of US default, I wouldn’t want to have my money anywhere else but in the US Dollar.