Monday, August 3, 2009

Critical Juncture for Dollar and Stocks

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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The dollar began to break down on Friday. Intraday, it fell below the critical 78.33 support level, but managed to close at 78.38. It is hovering just above 78.00 this morning. The next few days should tell whether or not it is making a bottom or just falls apart. This is probably just as important for the stock market because the dollar and stocks have been moving almost perfectly inversely to each other since early March when the dollar peaked and stocks bottomed. A dollar rally should mean a sell off in the stock market.

The close and opposite relationship of the price movements of the dollar and stocks is unusual. The 1990s bull market took place while the dollar was rising, not falling. The same was the case for most of the 1982 to 1987 stock rally. So most of the long secular bull market from 1982 to 2000 was accompanied by a rising dollar. Much of the secular bear market rally that took place between 2002 and 2007 was accompanied by a falling dollar. The dollar dropping to new all-time lows in September 2007 because of the Fed's rate cutting campaign is what finally killed the rally.

A new dollar stock pattern seems to have begun last November when the dollar had a peak and stocks (and a few commodities) made a bottom. The initial relationship was quite jerky however and only smoothed out starting in March. Stocks going up and the dollar going down indicates a trade where people who go long stocks, short the dollar. Only the big banks, brokers and hedge funds are capable of engaging in this trade. It's not mom and pop investor. If the U.S. government is not going to let the dollar break down, this trade is going to have to reverse and stocks are likely to suffer.

While an inverse relationship between stocks and the dollar has taken place, this usual relationship for the dollar and gold has broken down. Gold peaked in late February and the sold off with the dollar until mid-April. It then rallied in early June and sold off again with the dollar until early July. This pattern makes no sense whatsoever. If the dollar rises, there is no reason the decoupling can't continue. August is usually gold's strongest month and gold acted very positively to Friday's GDP Report while the dollar had a vicious sell off. The reaction was so extreme that it looked like dollar traders actually read the report.

NEXT: Dollar Breaks Down

Daryl Montgomery
Organizer,New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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