Market Gains No Protection from Depreciating Dollar

Below is a weekly chart of the S&P 500 beginning in 1994. Clearly evident is the straight up move of the mid- to late 1990s, the 2000-2002 bear market, the 2003-2007 bull market back up to previous highs, and the 2007-2009 bear market, back down to 2002 previous lows.

Forgetting for a moment about all the complicated underlying fundamentals that drove each leg of the up and down cycles of the past 15 years of US stock market activity, if one were asked to forecast the stock market direction of the next 5 years, many of us would state the the market might just return to the previous bull market peak of S&P 1500.

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The stock market is currently over-bought having bounced mightily from its recent bear-market low print of S&P 666 to 1000. And, from a symmetry perspective, when looking at the market bottoming process of 2002-2003, one might expect more work/time around the S&P 800-900 level before the market heads up definitively toward its previous highs around S&P 1500. From a purely chart-based perspective, any pull back toward these levels would represent a longer-term buying opportunity.

However, the bull market from 2003 to 2007 was accompanied by the devaluation of the US Dollar from parity with the Euro (one Euro costs one Dollar) to a bull market peak of one Euro costing 1.6 US Dollars. Currently one Euro costs 1.44 US Dollars. More dramatically, in 2000 one US Dollar was worth 1.8 Swiss Francs. Currently one US Dollar is worth 1.06 Swiss Francs.

Over this time period a US investor would have made more money or preserved more buying power simply by buying Euros or Swiss Francs and converting them back into US Dollars. Even more so with investing in crude oil or gold.

In fact, one could argue that for the past decade, regardless of whether the US stock market was trending up or down, the real story was the devalution of the US Dollar versus other key currencies and commodities. Sadly, with our current exploding fiscal deficits, 0% interest rates, and lack-luster economy, this trend shows no sign of changing. The US, overall, continues to become a relatively poorer country, deeply in debt, with a standard of living that is artificially supported by the Chinese and Japanese purchase of our debt and the manipulation of their currencies to artifically low levels relative to ours to stimulate their exports.

Given these longer-term trends and structual fiscal problems, it seems likely that the US Dollar will continue to fall versus other more stable currencies or those currencies not artifically depressed to foster trade (the Yen and the Yuan). US investors would be well served to do as Jim Rogers has done, and convert dollar holdings into other more stable currencies, and buy commodities. Shares of stock in growing economies such as the BRIC countries should continue to serve a similar purpose.

Disclosure: Currently long FXA, FXE, FXC, FXF and continuing to accumulate gold and silver bullion coins.

Comments

[Mad Hedge F...:]

The writing is on the wall. The chickens are finally coming home to roost for the dollar, which has gapped since Thursday from $1.40 down to $1.4450 against the euro, and done even worse again the Australian, Canadian, and New Zealand currencies. Crude traders tell me that the weak buck is making oil go up, while currency traders inform me that it is strong crude that is causing the dollar collapse. It’s like an Agatha Christie murder mystery where all of the suspects are guilty. If we are on the eve of an economic recovery, many fear that the US will return to its old, evil, high consuming, high importing ways, and that the trade deficit will skyrocket. If is doesn’t, then you can count on burgeoning government borrowing to knock the stuffing out of the greenback. It sounds like a heads I will, tails you lose bet. This is not exactly a new trend. The chart below shows the purchasing power of the dollar since the Revolutionary War, and it has been mostly downhill since 1929. No, I have not been trading the market that long. Better to take your pay in Euros, American double Eagle gold coins, bushels of wheat, or barrels of crude.

Aug 04 12:06 PM

[Dr. O:]

Kind of a quiet reception for my little article. Perhaps an obvious and oft-told tale. I forgot to mention that I am long a good chunk of XLF. If the economy is perceived to be improving, and stabilization in financial markets is at hand, the banks are best leveraged to benefit from this perception.

Today I bought some waaaay out of the money USO calls for Jan 2010. Not only are the usual factors driving oil higher, there's a chance for action against Iran. See my Instablog for articles discussing this.

Aug 04 06:55 PM