Ask yourself a simple question: Do you believe that the U.S. dollar will appreciate over the next decade?
If you answered "Yes" you should be buying stocks. If you answered "No" you should be getting ready for a painful bear market. The argument here is simple, and is based on four assumptions:
Assumption 1: Share prices are more likely to rise when increasing volumes of money chase the same number of shares. If, on the other hands, lower volumes of money chase the same number of shares, prices fall. This is why the Zimbabwe Stock Exchange was the “best performing” stock market in 2007, with the benchmark index gaining 595% in 10 months as the government dramatically increased money supply.
Assumption 2: American investors can't provide the necessary funds to fuel a stock market rebound. Everyone knows about America's (negative?) savings rate, so it seems unlikely that American savings will push the stock market higher (as explained in Assumption 1). Some Americans used home equity to fund expenses, and this can't go on now that U.S. home values are collapsing. Factor in higher oil prices and a weakening jobs market, and you soon realize that there is less new money available for investment.
Assumption 3: If we assume that U.S. investors don't have sufficient funds for investment, it means that a U.S. stock market rebound will only be sustainable if foreigners are buying.
Assumption 4: Foreigners will refuse to buy U.S. stocks if the U.S. dollar continues to slide lower. It doesn't take a rocket scientist to figure out that a foreigner's investment in a U.S. stock can be wiped out by a depreciating U.S. dollar. As an example, if a Japanese investor invests in a U.S. stock that gains 5% while the dollar depreciates by 10%, he loses 5% of his initial investment. On the other hand, foreign investors will rush to buy U.S. stocks if the U.S. dollar comes back from the dead.
I admit that my analysis here is overly simplistic, and I agree that the greenback is only one of many factors that affect U.S. stock market movements. The point I am trying to make is that a meaningful U.S. stock market rebound is less likely to occur if the greenback continues to weaken. Considering that the trigger happy Federal Reserve is slashing interest rates and quickly running out of ammunition, only coordinated central bank intervention can save the U.S. dollar.
"History shows that, as a rule rather than an exception, multilateral coordinated interventions have been key in establishing turning points in multi-year trends in the major currencies in the past three decades," says Stephen Jen at Morgan Stanley, in a note published on March 17. "The preconditions for coordinated interventions are not yet met. However, given that a weakening dollar is fueling dangerous vicious circles through commodity prices and eroding confidence, it is prudent to remain on an intervention watch, monitoring closely whether the preconditions for interventions are met."
Perhaps Wall Street's ultimate bailout will come when central banks coordinate efforts to save the U.S. dollar...