Rally 'Round The Dollar

The equity markets staged another rally. In keeping with recent trends commodities prices rose and the dollar fell. The relationship between the falling dollar and rising equity prices may not always exist, but it is currently a reality. Traders know full well that it is government stimulus and the printing of money and issuing of debt that is weakening the dollar and pushing asset prices higher. However, traders in different areas of the capital markets are expressing very different opinions. Most fixed income market participants acknowledge that he run-up of asset prices, including their own securities, is due to current monetary and fiscal policies.

Many equity market participants would have us believe that the resurgent asset prices are based on strengthening fundamentals. This reminds me of 2008 when oil wonks tried to convince us that rising oil prices was due to increasing demand. Anyone with half a brain knew it was a dollar hedge. When the financial crisis ensued, investors flocked to the safety of the dollar and oil prices plummeted. Some oil traders tried to explain that away by saying that oil dropped because the economic crisis was going to slow the global economy and reduce the demand for oil. This theory is blown out of the water by the current oil market. Last week, the International Energy Agency revised downward its forecast for oil consumption. However, oil prices continue to rise. Oil, gold and equity prices area all the result of a weaker dollar. Even higher high-yield bond prices are due to government stimulus. Without the government over stimulating the economy, many of these companies would not be able to refinance their debt by selling it to euphoric investors. At some point, these new bonds along with existing bonds coming due in the next five years, will have to be refinanced. This could be problematic once government stimulus is gone.

Beware of those who point to previous economic recoveries, such as 1983. I have written extensively on why the 1980s recovery is very different than today's recovery. The Wall Street Journal correctly points out the difference, not the least being that in 1983 interest rates were still very high. All the Fed had to do was to ease to reinvigorate the economy. Also, the S&P is trading at 7 times earnings rising to 10 times. When the current rally began the S&P was already at 13 time earnings and has risen to 19 times. According to the Journal the average is 16 times. The Journal also correctly points out that tax policy was becoming more business friendly in the 1980s. There is no such trend on the horizon now. All in all, this rally is only as strong as the greed which is fueling it.

Today's three-year auction was very well received by investors, especially indirect bidders which include foreign central banks. I am expecting a strong 10-year auction, in spite of more supply coming to market and fed policy which is weakening the dollar. If one is an exporter, one must do what one can to slow or stop the dollar slide to keep one's goods competitively priced. Later this week we will discuss the shape of the yield curve.