Sense on Cents

Is our economy stabilizing? Is yesterday’s surprisingly strong employment report a harbinger of a trend toward better days? While I am not going to indiscriminately pooh-pooh economic reports which may be overly sanguine, I am also not going to blindly buy into them either.

Let’s return to the surprisingly weak employment report produced in November, combine that with the report released yesterday and realize that the economic road in front of us remains long, steep, and challenging.

Prudence dictates we neither get overly ebullient nor despondent as we manage our finances and navigate the economic landscape. In that context, I will caution readers here at Sense on Cents that news deemed positive for the economy may very likely generate negative returns across a wide array of asset classes. Why is that?

The fuel that has been driving the markets all year is provided by the Fed and Treasury. That excess liquidity has served to punish the value of the greenback while supporting virtually all asset classes via the dollar carry trade. If the economy shows signs of stabilizing and the fuel source is restricted via a Fed-tightening of credit, the U.S. dollar should rise and hedge funds, speculators, and selected investors will be forced to exit positions across these asset classes. That very phenomena played out to a small extent just yesterday. Will it continue? Watch the U.S. Dollar Index and expect that it will continue to be negatively correlated with the markets.

Let’s navigate. Prior to reviewing the month to date market returns, I’ll address economic data released this week.

ECONOMIC DATA

Unemployment Report: The only data that was truly meaningful. Rather than regurgitating my analysis of this report, I submit my comprehensive review from yesterday “Unemployment Report: December 4, 2009.”

Let’s move along to market performance. The figures I provide are the weekly close and the month-to-date returns on a percentage basis:

U.S. DOLLAR

$/Yen: 90.51 versus 86.38, +4.8%
Euro/Dollar: 1.4856 versus 1.5007, -1.0%
U.S. Dollar Index: 75.75 versus 74.80, +1.3%

Commentary: the overall U.S. Dollar Index rebounded strongly after the surprisingly strong Unemployment Report. Why? Very simply, if the economy is starting to stabilize then the Fed will be faced with tightening its easy money policy much sooner than forecast. In fact, that is exactly what happened. While prior to yesterday’s release of the employment report, most market participants believed the Fed would be on hold for all of 2010. Now, however, the market is projecting the Fed may very well be forced to raise rates by mid-2010. If that occurs, the dollar will continue to firm. See that U.S. Dollar Index I linked to above?Watch it like a hawk. As the dollar goes one way, look for the markets to go the other.

I continue to reiterate my points from previous weeks: while I think Washington is not disappointed in a relatively weak dollar, although they should be (“Dollar Devaluation Is a Dangerous Game”), other countries are not overly keen about further dollar weakness. Why? A weak dollar puts those countries in a marginally less competitive position in international trade.

I also would like to reiterate that although Fed officials play up the lack of inflation as a positive and an overriding reason for its easy money policy, they provide little to no commentary on deflationary pressures at work in large segments of the economy. I firmly believe these deflationary pressures are the Fed’s gravest concerns and they hope the weak dollar creates hints of inflation to offset these deflationary pressures. Can rising asset valuations support underlying economic fundamentals which provide little to no pricing power for many companies?

COMMODITIES

Oil: $75.78/barrel versus $77.33, -2.0%
Gold: $1162.1/oz. versus $1180, -1.5%….
DJ-UBS Commodity Index: 134.79 versus 136.49, -1.2%

Commentary: the red ink in this sector is directly correlated with the improvement in the dollar. A lot of hedge funds had sold the dollar, given the fact that it could be borrowed for next to nothing, and used the proceeds to buy commodities. As the dollar rallies, that part of these trades loses, and thus as entities cover their dollar shorts, they sell out their long positions in commodities, especially gold.

Our economy is so large and so complex that it is not possible to turn on a dime as some may like to project. When hotel rooms in prime Las Vegas hotels are offered at $49 a night, we are a long way from a stable economy.

Please join me tomorrow evening as we discuss any and all of the above on Open Mike Night from 8-9pm on No Quarter Radio’s Sense on Cents with Larry Doyle.

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Have a great day and weekend.

LD

This entry was posted on Saturday, December 5th, 2009 at 10:41 AM and is filed under General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.