Dollar's Decline Has Contributed to Market's Recent 'Rise' 15 comments
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As you’re no doubt well aware, the US stock markets have been on an absolute tear since March 2009. Indeed, October stands as the first month stocks closed at a loss this year, which means the market had seven straight winning months in a row. That has to be some kind of record. 
The mainstream media, looking at the above chart (and the Fed’s proclamation that the recession is over), believe we have entered a new bull market. I will admit, at first glance the market does look as though it’s managed to beat every significant down turn and explode higher.
The only problem is that the above chart is priced in US Dollars: a currency that has lost 15% of its value this year. Remember, investing is all about relative value: assets do not rise in value in a universal sense. Instead they rise relative to other assets.
Here’s a chart of the S&P 500 priced in euros:
As you can see, US stocks, when priced in euros, have largely been trading sideways for the last three months. I should also note that they had a significant down-turn from May-July (a period that doesn’t look nearly as negative when the S&P 500 is priced in US Dollars).
However, the most critical element of the above chart is the fact that the market (priced in euros) is bumping up against major support. As you can see, the market has bounced at this level no less than three times before. The bounces from this level have gotten larger, but stocks have never managed to avoid returning to this line. If stocks break below this level, this forecasts a significant collapse (the gap down goes to 6.3, a full 10% lower than today’s levels).
Ok, that’s the case for the market priced in euros… but what about Japanese yen?
Practically the exact same chart: 
Again we see the market (priced in yen) trading sideways since August and testing a line of major support. And again, if this line is broken, there is a major gap down.
How about the market priced in Swiss francs?
Almost identical: a sideways trading range since August, multiple tests of major support, and massive potential gap down.
All of the above tell us several things:
- All of the gains the S&P 500 has shown since August are mainly the result of the US Dollar losing value
- The US markets, when priced in almost every major world currency, have been trading sideways for three months now
- Priced in other currencies, the US markets are showing serious signs of a potential break-down coming (there are major gaps down in every chart)
These charts are flashing very serious warning signs that the US market has put in a major top. Far more importantly, there is the potential for a very serious collapse in US stocks. And it’s showing up in virtually every currency.
I’ve stated repeatedly that I believe stocks will have another Crash this year. Looking at the above charts this could be coming sooner rather than later. When you price it in US dollars, the S&P 500 looks like it’s rising. But in any other currency, US stocks have gone NOWHERE for three months now.
Folks, the market rally since August hasn’t actually made any of us richer… it’s simply that our currency has gotten weaker. Either the Dollar strengthens from here (which would kick US stocks off a cliff since most of their gains are a result of the Dollar losing value) or it rolls over, tests new lows and US stocks (priced in Dollars) explode higher.
Neither of these situations is positive. If the Dollar rallies, stocks could collapse which would decimate retirement accounts. And if the Dollar rolls over and stocks explode higher, we’re all poorer for it, too (stocks will not have hit new highs based in other currencies).
Now is the time for extreme caution especially for those of you in the US. Either way you slice it, a major top has likely formed in US stocks. And either way you slice it, a lot of people are going to lose a lot of money in the near-future.
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This article has 15 comments:
Graham:
Nice work!
You do an excellent job of documenting the fruit of quantitative easing: A weak dollar, and illusionary "gains" in U.S. financial assets.
The illusion works for now, since Americans do not realize that we have sold our future for a McMansion and a 46" TV. The investment implications of your work are bullish for gold and commodities, and EXTREMELY BEARISH for U.S. government bonds.
Why? America has debts it cannot pay, and a currency it cannot support. As Medicare and Social Security become cash expenses in the next three years, we face default on our debts or a devaluation in our currency. The math simply doesn't work anymore, and foreign investors know it.
Thank you very much for your excellent work in documenting this alarming development. Well done.
Rob
It was early morning, and I had already polished off my second cup of convenience store coffee, so I took this as an opportune moment to take a rest break. I pulled off onto "Ben Bernanke Interchange," hit the nearest gas station and went into the men's room where I left a steaming 2 lb "deposit" in respectful honor of what this great central banker has done for my US dollars.
Thoroughly unburdened, I headed off to Florida.
2. A majority of Americans refuse to distinguish between money as a store of value and dollars as a medium of accounting and exchange.
This why they complain about rising oil prices when oil prices are not rising relative to other real assets. It is the dollar that is falling but relative motion often deludes the stationary observer into believing she is moving versus a stationary object.
The S&P priced in gold would have been an enlightening chart. I wonder why CNBC never shows us that one?
One can almost hear poor Winston, taking a break from "revising" numbers on chocolate rationing, scanning over the charts and recent GDP numbers; muttering how doubleplusgood it all must be...
S&P priced in gold has basically been crashing unabated since 2000.
static.seekingalpha.co...
The risk is that a sudden countertrend move up in the dollar could force traders to unwind the carry leading to a massive drop across an entire spectrum of asset classes, rendering beta coefficients meaningless as a measure of non-systemic risk. The immediate aftermath of the Lehman collapse resulted in a hegde-fund style 'bank run' on the markets as massive redemption requests and margin calls on downgraded collateral led to widespread liquidation. Stat arbs lost money because historical relationships broke down, but did not immediately self-correct, i.e. when crap hits the fan all bets are off.
Although most traders are aware of this, they cannot *not* participate. They can only hope that they will be on the right side of the market if a move up in the dollar comes. The problem with this mentality is that it doesn't factor in Game Theory prisoner-dilemma scenarios when everyone rushes to the exit simultaneously in a zero-sum panic. Given the strong behavioral elements at work in the capital markets, this is a legitimate concern.
While I've stopped shorting the dollar, and have been reducing exposure to commodities, I am watching for Stimulus IV and more photoshopping before deciding if our nominal rally will continue...
I've been riding the wave but have elected to be quite conservative for now.