Ronald Reagan was fond of saying ‘The government that governs best is the government that governs least.” Occasionally he would even credit Thomas Jefferson or John Locke for the quote. It actually comes from Henry David Thoreau’s Civil Disobedience. Reagan loved the phrase because he thought it was a wonderfully concise way to say that government should not intervene in people’s lives absent any compelling interest. With that in mind, one would think that, wherever he is, Reagan must be pleased with the Biden Administration for accomplishing next to nothing — despite no lack of trying. So, it seems we will not be worrying about that 3.5 trillion-dollar spending bill. Here at the shop, we think that is a good thing.

On another note, we’ve talked a lot about Covid19, inflation and supply chain issues in recent months. But there is an angle that we have not spent a word on for a while. Forgive the mixed metaphor but I’m reminded that optimists will be optimists, pessimists will be pessimists and the grass is always greener on the other side of the coin. The coin in this case is the US Dollar, which has been taking a bit of a beating in the currency markets. If you are wondering why that is, well it’s the other side of Inflation. We tend to think of inflation as prices going up but the inverse of that is the value of money going down. Who is likely to benefit from a falling dollar? Emerging Markets, that’s who.

Lyn Alden Schwartzer has been following this recent trend and writes:

“Emerging markets generally have a lot of dollar-denominated debts. Un-intuitively, most of these debts are not owed to the United States; they are owed to other countries such as China, Japan, Switzerland, and so forth, but are denominated in dollars.

When the dollar strengthens, it increases the value of those debts, which is bad for emerging markets all else being equal. When the dollar weakens, it decreases the value of those debts, which is good for them.

All of the major emerging market bull markets in history occurred during dollar-weakening environments. If this dollar reversal has legs to the downside, that could be great for emerging markets.

Indeed, the S&P 500 ETF (SPY) to iShares MSCI Emerging Markets ETF (EEM) ratio recently hit overbought levels and then rolled over with negative momentum. In other words, after a strong period of US stock outperformance over emerging market performance, emerging markets are starting to make a comeback”

I hasten to add a very important caveat. What all of the above means is that it’s time to put Emerging Markets back on the radar. We love Technical Analysis, but we also hate sloppy data. A side effect of the pandemic is that a lot of the economic reports that everyone relies upon are extrapolations of samples. Collecting data has been a real challenge over the past year or so. It will continue to be for a while longer. And, if the pools of data are contaminated, any conclusions based on that data will also be tainted. We’re optimistic. But cautious.

Ron’s Market Minute – A Weaker Market

Inflation is the word of the day. It’s running hot and the Fed, as usual is late to recognize what ordinary Americans have known for many months. So finally, the Fed is gearing up to fight inflation with a series of rate hikes, but first they will need to taper their bond buying program to reduce market liquidity. It sounds like a straight-forward process. Their intent is a slowdown in economic growth without a recession, but there will likely be some surprises along the way. The Fed has just not managed to engineer soft landings. By the time they get the excess liquidity problems under control and start raising rates, there is a good chance that the seeds of a recession and a potential bear market will already be starting to sprout.

Let’s look at last week. Investors have moved en masse from holding boatloads of ‘growth stocks’ to holding boatloads of ‘value’ stocks. The typical reasoning is that in an inflationary environment, the future earnings (the reason investors own growth stocks) will be worth less than in a low or non-inflationary environment. With the shift to value, we’re seeing dollars flow to the defensive sectors- and Utilities, Consumer Staples, Financials (banks reporting earnings this morning- they love the thought of higher interest rates!), and Energy. We note that investors are not running, just moving to more conservative places. The past several years has shown significant out-performance by the Nasdaq Index vs. the more traditional S&P Index. In my view this is ending- at least for now.

The move from growth to value is normally (not sure what ‘normal’ is these days) a rolling change. It’s been rather a surprise how quickly the shift has happened this time.

 No one knows the future (our crystal ball is a bit cloudy), but 2022, in my opinion, is likely to be a difficult and volatile market environment. In the short-term, we have Covid and inflation and labor shortages to worry about. In the longer-term, we don’t even know what the problems will be, much less how an inept political and Fed leadership will deal with those problems. It all sounds a bit foreboding, but it really isn’t. I’m certainly not predicting a bear market in 2022, but if it does occur, that will be a potential gift for investors who focus on risk management. The easiest money always comes after a bear market. The key to success is to have your capital base intact as possible when the bear market ends.

In the short-term, the market outlook is very uncertain, and the potential gains don’t justify the risk in the current market environment. With that in mind we have moved over the past two weeks toward a much more conservative posture. That could change quickly. If it does, we will adjust quickly. In the meantime, patience is called for while we assess the evolving market environment in a new trading year that is shaping up to be quite different from the past couple of years.

Ronald P. Denk, CFP®
Investment Advisor
Denk Strategic Wealth Partners
10000 N. 31st Avenue, Suite C-262
Phoenix, AZ 85051
Phone (602) 252-8700
Fax (602) 252-8701
Toll-Free (877) The-Denk


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