There is an old joke about two hiking buddies who inadvertently startle a bear cub deep in the woods. As the enormous, and now angry, mama bear wheels and prepares to charge, one of the hikers quickly sheds his backpack. “You’ll never be able to outrun that bear,” his buddy tells him. “I know,” he replies, “but I don’t need to outrun the bear. I just need to outrun you.”
Such is the current situation of the U.S. dollar, which is currently hitting recent highs against the yen and euro. Has the fiscal responsibility of the U.S. suddenly improved in a material way? No. Has our deficit been reduced? No—in fact, it is larger than before. So what, then, accounts for the recent strength in the dollar?
After the recent downgrade of Greece, investors became focused on the fiscal problems of Europe. In addition to Greece, Spain and Italy also have large public sector debts that are rapidly growing. And all of a sudden, the U.S. dollar doesn’t look so bad on a relative basis.
This speaks to the power of relative strength analysis in financial markets. The dollar may not be able to outrun the bear in the woods, but right now it just needs to outrun the euro. Investors everywhere always face a dilemma: where should I put my excess capital? After all, it has to go somewhere. The decision is always a relative one—what is the best choice among the options I have? Our Systematic RS accounts take advantage of this relative decision process by constantly measuring the relative performance of stocks or asset classes and attempting to focus the portfolio in assets that have been strong. Relative strength analysis allows the investor to see, from a pure supply and demand standpoint, uncluttered by rhetoric, what decisions have been made in aggregate and allows the investor to follow the trend.
