Does Greece matter in the global financial environment? Absolutely, hopefully my last posts help to explain why. Let me throw out one more thing: concerns in the Euro Zone can also adversely affect the U.S. by a “flight to quality” to the US Dollar. Is a stronger dollar so bad? A weak dollar is a necessary precursor to, but not an absolute prerequisite, to higher asset class prices.
The hedge fund community currently has a huge currency “carry trade” on. (A carry trade is where you borrow and pay interest in order to buy something else that has higher interest. For currencies, it might be that you borrow in a currency (where the interest rate might be low) and use the proceeds to purchase another asset. While the trade might produce a positive return, it is risky in two dimensions. First, interest rates of the borrowed currency could increase diminishing the value of the asset that you purchased. Second, the exchange rate could take an unfavorable move effectively increasing your borrowing costs.) In our case, the borrowed currency IS the U.S. Dollar. If the U.S. Dollar gets stronger, the probability of a carry trade unwind also increases. Should that occur, asset class positions financed with borrowed dollars would come for sale across the board. The stock market could go down precipitously as stocks (and other assets) are liquidated with no regard to price or value. THIS is the time when having a large cash position will be beneficial. Should this happen, caution is still urged though until we’re sure all of the damage is done.
1 comment:
I received a question: "Are you saying that the average investor should be largely in cash right now?"
The answer depends on your risk profile. I'm not sure what the definition of an "average investor" is. The purpose behind my comments were to make people aware of the risks out there right now. Risks, that in my opinion, are not well-understood and that are not being properly explained by our government or our press.
There's a good reason that our government is not talking about these risks. To do so could incite fear causing a run on banks. That's what happened at Bear Stearns and Lehman's.
But my point is to make you aware of these risks so that you can make an informed decision if the rewards of being in the stock market and in being in specific stocks is worth the risk. If anyone wants to share specific situations with me, I cannot tell you what you should do, but I may be able to tell you what I would do and what others are doing.
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