Investment Implications of a Dollar Bottom

I was at an Xmas party last night and asked how can the Dollar rise when we have such excess liquidity from Helicopter Ben and such low rates under ZIRP (zero interest rate policy)? I explained that it would happen if the US Peso fell slower than other currencies. Of course there is more to it than that, including the potential short squeeze against the Dollar Carry Trade, but the essential point remains: when all countries are racing like hares to the bottom, the turtle currencies will rise.

Right now the Japanese are facing a double-dip economy, and hence a weaker Yen; and Euroland is facing a growing number of sovereign default risk (Greece etc.), hence a weaker Euro. While this is unlikely to pull down the global economy, it seems to be driving down the Euro, which is down big today. It is also emboldening the Bond Hawks, who are putting pressure on countries pursuing a weak currency.

For a week I have been on Sea Change Watch: has the Dollar bottomed? The key was whether the pattern of a Dollar Dump Sunday and a Stock Pump Monday would continue – it didn’t. Yves then weighed in on the Dollar Carry Change ending.This chart and the commentary from Bespoke Investment Group show broader recognition of this change. Their investment recommendation:

• shift from multinationals with heavy overseas revenues (where a weak Dollar helps)

• to those with heavy domestic revenue (where a strong Dollar helps).

In other markets, we see:

• the bursting of a gold bubble

• the fast drop in oil. Yves has a piece at ZH on oil.

In equities we are in the early stages of the Santa Rally. How can the Dollar drop and the Dow rise? The inverse correlation is well recognized but not precise. A lot of it comes from overseas investors hedging the Dollar drop in US equities. Now they have troubles in their homelands. Also, institutions are beginning to lighten up for the holidays, and the retail investor is driving equities. Why else the Santa Rally? These folks are impervious to larger Forex trends. Watch for equities to catch up to the Dollar Bottom after the new year.

In the near term, be prepared for a Dollar pullback and Euro bounce. We might get a mini-version of the Sunday Dump over the weekend, but this is more a technical bounce than a change back. If so, we should also get a Stock Pump next week, especially leading into the FOMC meeting mid-week.

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