Dollar Index and the Rally


September 21, 2009
*****The Dollar Index  
*****3Q Earnings Surprise?
*****$50 Coupon
Fellow Investor,
The chart below demands our attention…
There should be no doubt that the Cash for Clunker Stock Rally is directly related to the relative value of the U.S. dollar. Please note the strong support at 76. Also note that the dollar rallied hard from 76 starting in September 2008. That was when Lehman collapsed and money rushed for the safe haven of Treasuries.
The highs in this chart coincide with the highs for Treasury prices.
Money began flowing out of Treasuries in March, when the risk scenario began to change due to the combined forces of extremely low yields on T-bills and attractive valuations for stocks. Of course, massive Treasury auctions also pressured prices, encouraging money to flee the safe haven and seek higher returns with more risky assets. That was essentially by design.
Now, as the US Dollar Index hits that 76 support level again, we are at an interesting juncture. We might expect the dollar to rally from the 76 level. That will pressure commodity prices and also stock prices. 
*****This morning, we are seeing oil, copper and stock prices show weakness. This is as much a fundamental reaction to the dollar as it is a statement about the economic health of the US economy.
Bloomberg reports that companies have raised cash at the fastest rate in decades. Cash relative to share prices are at 20-year highs. And that cash is being put to work, as the recent announcement of several acquisitions can attest. Just today, Dell (Nasdaq:DELL) announced a $3.6 billion acquisition of Perot Systems (NYSE:PER).
*****The doom and gloom crowd has been calling for record Treasury auctions to utterly destroy the US dollar and bring about runaway inflation. So far, neither has happened. And despite Russia’s pleas for a new global reserve currency, foreign governments continue to show a healthy appetite for Treasuries. China added $24 billion in Treasury bonds in July, and its total holding have risen 10% to $800 billion this year.
The twin forces of consistent buying interest and record supply should be expected to act as a cap on prices, and the dollar’s value, and also keep interest rates low.
*****So what does this mean for the Cash for Clunker Stock Rally? Good question. There is concern that stock valuations are too high for the current level of economic activity. And it’s not just in the U.S. Bloomberg reports that the MSCI Emerging Markets Index, which tracks 22 countries, is at the highest levels since 2000.
Sounds bad, but keep in mind that valuations are looking forward. If the global economy stayed at current output levels, then yes, stocks are overvalued. But investors are looking ahead, when growth justifies valuations. And they’ve been right so far – economic data has, on the whole, been better than expected.
And even now, there is some cause to be bullish on the economy and stocks. The Chief U.S. economist at Barclay’s, Dean Maki, believes the U.S. will actually start adding jobs by the end of this year. In fact, he believes the jobless rate is at its highs now, and won’t crest the 10% mark. Needless to say, that would be an extremely bullish surprise. Unemployment above 10% is widely expected.
*****Third Quarter earnings starts on October 7, with Alcoa (NYSE:AA). Many investors are nervous about Q3 earnings. They don’t believe revenues have grown enough to continue the profit gains that were achieved by cost-cutting in the Second Quarter.
But the bears have been consistently wrong about the economic recovery. The undercurrent of low expectations has been very good for stock prices. And so I can’t help but think we could be setting up for an upside surprise when Q3 earnings begin.
*****I’d like to thank Daily Profit readers again for your support for my book The Small-Cap Investor: Secrets to Winning Big with Small-Cap Stocks. It’s doing great so far, and you’ve been a big part of that success.
Don’t forget – when you get your copy, you’ll also get a coupon good for $50 off an annual subscription to SmallCapInvestor PRO or any of my other advisory services.
With this $50 coupon, it’s like getting 3 months of the top-performing SmallCapInvestor PRO for free. Helping you make money is the best “thank you” I can think of.
Until tomorrow,
Ian Wyatt
Daily Profit
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