The Milkshake Trade Is Finished

Think back to this past summer. The US dollar was rallying hard, having risen from 88 DXY in the spring to 97 as August drew to a close. At the same time, the American stock market was on fire, tacking on 400 S&P points in less than half a year. This was happening while the rest of the world’s stock markets were sucking wind. Europe was down a handful of percentage points, the MSCI world index ex-US was down a similar amount and emerging markets were being beaten like Marvin Nash at the hands of Mr. Blonde. In the period when the S&P had risen almost 10 percent, emerging markets were pushing down 15%. When you combine the meteoric US stock market rise along with the USD appreciation, the relative outperformance of US equities for overseas investors was stunning.

I understand all the reasons for the move. America was the only major country engaging in fiscal stimulus. They were also cutting taxes and engaging in pro-business deregulation. These policies allowed the U.S. Central Bank to pursue a tighter-than-would-otherwise-be-the-case monetary policy.

All of these circumstances combined to create a virtuous self-reinforcing feedback loop. As foreigners chased U.S. stocks, it put a bid to the U.S. dollar and also loosened financial conditions which caused the Federal Reserve to tighten policy which caused the U.S. dollar to rise even more and encouraged foreigners to buy even more stocks. It became reflexive.

Wall Street always does this. They take a good idea, and they push it too far. The US-will-eat-the-world financial theory made a lot of sense… at first.

I am about to embark on a reason to sell US assets, but make no mistake - I am not disputing any of the reasons to own American assets, merely disputing whether those reasons are already in the price. Don’t send me a list of all the reasons why Europe is $%#%’d or why America is the undisputed global superpower with a military and economic power unmatched by any rival. I get it.

I understand Santiago Capital’s Brent Johnson’s “Dollar Milkshake Theory” In fact, even though I didn’t agree with Brent’s call, earlier this year (when the whole world was bearish on the US dollar) I brought the loneliness of his prediction to everyone’s attention with a piece titled “US Dollar - Up then down?

…there are others who believe the flow of funds from managers choosing the most attractive destination for their capital means more. My favourite US-dollar-bull-yet-still-gold-bug buddy Santiago Capital’s Brent Johnson created this great presentation outlining his arguments for why the US dollar is poised to rally.

As I was watching, I realized that Brent was one of the few pundits willing to say the US dollar was headed higher - not because of structural problems in the Eurodollar funding market or from a short squeeze in US borrowers paying back money - but because the US is the best economy out there. I might not agree with Brent, but I felt a certain kinship with his lonely call. Often the best trades are the ones where the fewest agree with you. I joked with Brent that it almost made me want to join him on the US dollar long side.

The investor is in me is convinced Luke and Mark are right that the US has entered into a long period of decline, but the fact that MacroVoices couldn’t find a single bull to make the US dollar bull argument makes the trader in me think that Brent is going to be right in the coming weeks and months.

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