Interview With an Equity Strategist

I recently had the opportunity to chat with Sean Darby, global head of equity strategy at Jefferies Group (JEF), following a presentation he gave to a group of hedge fund investors in Manhattan. Darby is a sharp strategist who spends most of his time in Hong Kong. Before joining Jefferies, he was Institutional Investor's second-ranked Asian strategist while plying his trade at Nomura.

At the beginning of the year, Darby forecast a positive double-digit return for the S&P 500 and stated that U.S. equities would be the top-performing financial asset class in 2012. In short, he has been bullish -- and correct. The thrust of his argument is that the U.S. economy has been exporting inflation to emerging economies while undertaking the arduous task of lowering domestic production-cost structure. When the effects of a multiyear decline in the U.S. dollar is combined with the dual impact of negative wage growth in the U.S. and double-digit wage inflation overseas, our economy has stealthily become highly competitive in the global markets -- even in manufacturing. Darby presented extensive quantitative evidence to support his thesis. Although my view is that this remains a work in progress, Darby is of the mind that the heavy lifting is already over and the dividends are already beginning to accrue.

One of the most important takeaways from this successful restructuring, in Darby's view, is that the U.S. dollar has entered a secular bull market. Having been burned too many times in the past by our ultra-easy central bankers, I'm too skittish to make such a call, preferring to predict an ongoing cyclical bull market that might last a while. With the other members of the Fab Five central bankers intent on printing money with abandon, this is one race even Team Bernanke might lose -- especially if U.S. rate increases gain upward momentum. One of the more striking points in Darby's presentation was that the Swiss National Bank was by far the most aggressive money printer over the past year. This was of course in response to the soaring franc vs. the wobbly euro. (Those who view the Swissie as hard money, take note!)

Another interesting discussion we had involved the current valuation of the Chinese renminbi. A recent Financial Times story suggested that the yuan had reached equilibrium with the U.S. dollar. Darby and I agreed with that conclusion and now expect China to integrate its currency more aggressively into the global financial system, especially since it might now fall in value against the dollar.

Of course, there was no avoiding the 800 lbs. gorillas in the room: The eurozone, European Central Bank policy, and the implications of the Long-Term Refinancing Operation (LTRO). In the past, I have described it as QE-lite. From my perspective, it is not true quantitative easing, simply a hybrid maneuver to entice banks into engaging in behavior that resembles the effects of quantitative easing. Simply put, it allows banks to exchange trash for quality loans, a portion of which will work their way into the European sovereign bond markets. Apparently, I found a kindred spirit who sees the action in a similar vein, with the concomitant fear that additional debt write-downs in the eurozone are probable.

Darby sees Portugal and Ireland as likely heirs to Greece in the debt restructuring process, and fears Spain may join as well. His biggest fear, as is mine, is that Italy might require debt relief as soon as 2013. Anyone wondering where the next systemic shock might come from need look no further. Of course, this wouldn't be a "Black Swan" event; it would more properly be characterized as "The Birds: The Sequel."

Near term, Darby says that equity markets are vulnerable to profit-taking and selling pressure, mostly generated by continued political and economic uncertainty in the eurozone. Shockingly, he sees the solution to the European debt crisis being enacted by a Germany that accepts higher inflation as a means of rebalancing European economies. Surely, this process alone will be painful, drawn out and not readily accepted by market players, myself included. I simply don't see Germany writing the check, either implicitly or explicitly.

Circling back to commodity markets, Darby sees the global demand for protein driving a powerful bull market in agricultural products, especially in corn and soybeans. His views on industrial metals, energy and precious metals were mixed. He sees $4 per gallon U.S. gasoline and $120 per barrel Brent crude as sufficient to generate enough economic headwinds to keep other commodity prices in check. An important aspect of his energy views involves the enormous growth in natural gas reserves through fracking and other extraction processes. He believes that the U.S. will have a net energy surplus (value of nat gas and coal exports minus imports of crude) by 2025, perhaps sufficient to generate a trade surplus for the U.S. even sooner.

The investment implications are straightforward: Investors should be long the U.S. dollar and buy U.S. equities on an expected summer dip. Refrain from buying U.S. Treasuries and temper expectations for strong advances in most commodities. Grains, however, represent a structural opportunity and additional upside is likely over the intermediate term.

At the time of publication, Casa was long the U.S. dollar against the Japanese yen and Australian dollar.