Friday, July 31, 2009

"...the Slope of Hope."

The Slippery Slope of Hope

Have you noticed how strongly the Canadian dollar and US stock market are correlated lately? Every day that the stock market ticks up, the Canadian dollar ticks up too. In fact, if we check the long-term trends, this correlation dates back to 2002. From 2002 to 2007, the US stock market went up and the Canadian dollar went up.

For Canadians, another way to describe a strong Canadian dollar is “a weak US dollar.”

But the US dollar’s weakness went hand in hand with world stock market strength from around 2002. Not only that, but the weakening US dollar accompanied stronger prices for agricultural commodities, basic materials and energy. It seems we can tell the story of world economics by following the story of the US dollar.

How can we use this information for managing our investments?

In a previous article, we wrote that the 6-year US dollar down trend that started in 2002 and ended in 2008: “… the US dollar bottomed at a price of 71 currency basket units. Then, in the last half of 2008 it rallied to 88 units, dropped to 78, surged back up to 89 and dropped back down to 79: all this in one year.” [See “How to Break the Banks,” July 17, 2009]

Does the end of the decline of the US dollar proclaim the beginning of a down trend for world stock markets, commodities, materials and energy prices too?

That is exactly what it means.

In “How to Break the Banks,” we illustrated how the long-term weakness of the US dollar undermined the world’s banking system because the US dollar is the banks’ reserve currency. If the dollar gets weaker, it will put pressure on the world’s banks at a time when they are already shaky. But, if the correlation between the US dollar and the market continues to hold, a strong US dollar will put pressure on the world’s stock markets and commodities markets. The US dollar and the world’s banking system have a direct correlation: both are strong or weak at the same time. But the US dollar and the world stock market have had an inverse correlation for the past ten years: when one was weak, the other was strong,

Which will it be: a weaker banking system or weaker stock and commodities prices? Or, to ask the question from the other side of this correlation: a weaker US dollar or a stronger US dollar?

The only way the world can have strong banks and strong stock and commodities prices is for the US dollar and the markets to become uncorrelated. A new bull market in the US dollar would then help world banks, but not hurt the financial markets. Can they do it?

My book, Beyond the Bull, discusses two 10-year correlations between interest rates and the S&P500. For the first ten years, the stock market went up every time interest rates went down. For the second ten years, the stock market went up every time interest rates went up: the exact opposite. So, we know these correlations come and go. And we can always hope the US dollar vs. stock and commodities price correlation will go away too.

But managing your investments by hoping doesn’t work very well, as we learned in 2008 when the stock market dropped 40%+ in only a few months. Professional stock traders have a saying: “the slippery slope of hope.” When unsophisticated investors hold onto their stocks in a huge bear market, the traders mock them, saying: “They are sliding down the slippery slope of hope.”

Our advice? DON’T LOSE YOUR MONEY! If the slippery slope of hope develops because the world’s banking system needs a stronger US dollar, do what you wish you’d done in 2008. Cash in your chips and sit on the sidelines.

Ken Norquay, CMT
Chief Strategist, CastleMoore Inc

Links to my book, Beyond the Bull:




1 comment:

chrispycrunch said...

I believe that long-term treasuries will hold its values. It has to, in order for the market's rise to be "validated." If the market sells off, then money will want safety, which is out of favor. In the latter case, treasuries need to rise also. See TLT.

What do you think?