[Howard Agency]

Money Illusion - Part 4

We have commented many times that US investors need to pay increasing
attention to the value of the US dollar because of globalization. The notion that
one "eats and lives" in US dollars seems increasingly naïve given the global
backdrop and the flow of goods and services.

We have explained that a country's standard of living falls when its currency falls.
In other words, global goods and services become increasingly unaffordable to
consumers in a weak-currency nation. The example we like to use is that rising
gasoline prices are a repeated headline issue in the US, but have barely
influenced consumers in many other countries. Simply put, the standard of living
in the US is falling relative to those in other nations with appreciating currencies.
In particular, we have tried to acquaint investors with what we have called "money
illusion". Money illusion is the investment return in local currency that gives the
illusion of wealth building, but is merely a reflection of a weaker currency. In other
words, it takes more of a devalued currency to buy the same corporate assets.
When a country's stock market appreciates and its currency appreciates, that is a
very bullish sign. However, when a country's stock market appreciates and its
currency depreciates, then some portion of the gain can be attributed to mere
money illusion.

The US stock market has gone through bouts of money illusion as the US dollar
has fallen. Whereas the headlines trumpet "new highs" on the major indices, the
reality is that a good portion of the appreciation is attributable to the weakening
dollar. The chart on page 2 shows the Dow Industrials' performance so far this
year in US dollars, and in a basket of non-US currencies used in the DXY Index.
Even including Thursday's substantial rally in US shares, the Dow in non-US
currencies is actually down over the past 8 weeks or so.

Several points are worth making:

1) About half of the stock market's return so far this year appears to be
attributable to the weakening of the US dollar. The Dow is up about 11-12%
in US dollars, but it is up only about 6-7% in non-US currencies.

2) The gain attributable to the weakening of the dollar has been increasing as
financial market volatility has been rising.

3) The gap between the US dollar and non-dollar versions of the Dow began to
widen as the Bank of Japan began to raise rates and the "yen carry trades"
first appeared to be at risk.

4) Earnings, especially those of large cap multi-nationals, will benefit from the
dollar. Note that our profit indicators recently turned positive.
Most important, Americans might feel good about the stock market, but they are
not building true substantial wealth in a global economy. Responsible monetary
and fiscal policies need to be put in place.

Until then, we continue to look for opportunities outside the US, particularly in
developed Europe and consumer-oriented Japan, and continue to suggest that a
small portion of a dollar-based portfolio be in gold and/or gold shares.