Author: Steve Smith
Disclaimer: Steve Smith owns MON, SYT and DD in his Covestor Hedged Equity Model, International Hedged Equity Model and Christian Agape Model respectively.
October 5, 2010: The skirmishes in the currency market have escalated into open warfare. According to Brazilian finance minister Guido Mantega, the “international currency war” has begun. Although our Congress complains about China, the Federal Reserve has mounted the most aggressive campaign. By debasing the world’s reserve currency, the Fed has forced other central banks to respond in order to protect their own currencies. Productive growth in the U.S. requires fiscal policies that promote capital formation, regulatory policies that eliminate constraints and free resources for productive use, and sound dollar policies that promote confidence at home and abroad. These growth-oriented policies are not being pursued today.
Markets have responded to liquidity injections from quantitative easing (money printing) and the anticipation of further quantitative easing. Funds have gone into the financial economy rather than the real economy, resulting in higher prices for financial assets but no meaningful economic growth. This illusion of wealth may end at any time when traders stop gaming the Fed by front-running its weekly monetary moves (open market operations to buy Treasuries, flatten the yield curve by lowering longer-term rates, and push new money into the financial markets.) The diminishing returns from this front-running trade, in stocks and bonds, will ultimately lead to a correction in both markets.
We are hedged to protect against a downturn that we believe could be meaningful. Interest rates are artificially low and equity prices reflect earnings growth that will be difficult to achieve in a weakening economy. Our hedged positions will be increased as we judge the front-running trade to have run its course. Current equity holdings are characterized by their more defensively postured, cash generating operations. Sound balance sheets and significant dividend yields further characterize each of the three models we manage. All three yield more than 10-year Treasuries, have inherently more downside protection, and provide the opportunity to grow as well as preserve capital.
Fears of sovereign insolvency, massive devaluation and, ultimately, rampant inflation have led to a “growing” interest in farmland as an investment. We are participating through a derivative farmland play with positions in companies that sell seeds and related products to farmers. Monsanto (MON) has struggled since it lost patent protection on its RoundUp herbicide but still represents an attractively valued holding in our Hedged Equity model. Since good values are often found when profitable businesses stumble, we look for those opportunities. Syngenta (SYT) in International Hedged Equity and DuPont (DD) in Christian Agape Hedged Equity also represent companies well-placed to benefit indirectly from rising crop prices and farmland values.
