Systematic Relative Strength

Most economists are fond of measuring prosperity in terms of GDP. But according to Rob Arnott of Research Affiliates as cited in Fortune, that may not present a true picture of economic growth:

GDP that stems from new debt — mainly deficit spending — is phony: it is debt-financed consumption, not prosperity,” Arnott writes. “Net of deficit spending, our prosperity is nearly unchanged from 1998, 13 years ago.

The whole article is worth a read-and some serious thought. (It is perhaps of interest to note that the Value Line Geometric Index had a peak around 1998 also.)

Source: Yahoo! Finance

The implications for investment markets may be profound. If real prosperity is not to be found in the US at the moment, it may be necessary to broaden your investment horizons, both overseas and to different asset classes. Strategic asset allocation with a US core may need to be cast aside in favor of a more flexible tactical asset allocation approach. Relative strength, of course, is one good way to determine where returns are being made.

This is not new, but is perhaps interesting in relationship to our recent podcast on the US dollar. From the Los Angeles Times, here is the Fed’s contention:

The jump in oil and other commodity prices so far isn’t enough to make the Federal Reserve want to tighten credit, the central bank’s vice chairwoman said Monday.

In a speech in New York, Janet Yellen hewed to Chairman Ben S. Bernanke’s line that inflation pressures from higher commodity prices will be “transitory.”

“These developments seem unlikely to have persistent effects on consumer inflation or to derail the economic recovery and hence do not, in my view, warrant any substantial shift in the stance of monetary policy,” Yellen said.

Commodity prices have been surging, but the Fed’s current position is that it will be transitory and that they don’t plan to change monetary policy. In other words, they are not planning to raise interest rates. You have probably noticed that China, Brazil, and the European Central Bank have been raising interest rates. Those interest rate differentials are part of what is driving the US dollar lower.

Right now, cash is trash. Money market interest rates are below the level of inflation, and the declining dollar is adding to your loss in purchasing power. Cash is getting hosed in real terms right now. You can twiddle your fingers and hope the Fed is right, or you can modify your investment policy to seek out returns wherever they may be.