After the panic low in the stock market on Monday, August 24, traders were hoping for a “V” bottom, and stocks did bounce back quickly for a couple of days, But since then stocks have not made any progress and are again turning over. This action suggests that August low is going to re-tested. If that low does not hold, there could be a bloodbath.
Sometimes stocks become overpriced relative to their true underlying value, and sometimes we see the reverse. When stock prices are undervalued, the equity ownership conveyed by the stock is worth more than the price. The important point is that most investors do not factor into their economic calculations when evaluating stocks whether the dollar — the measuring stick — is itself overvalued or undervalued.
So will the dollar tank and remove some of the selling pressure on stocks? Or will a dollar rally make stocks look even more overvalued and increase the selling pressure?
If history is any guide, I expect the former. For decades the Fed has trashed the dollar in an attempt to paper over declining living standards to keep the U.S. welfare state afloat. Expect more of the same.
For this reason I do not think the air pocket the precious metals yesterday is a reason for concern. Gold in dollar terms is down 4 percent this year, but I expect gold to post a gain this year when the counting is done in three months.
This downtrend in the dollar has been underway for months. The dollar has been moving lower since the U.S. Dollar Index hit 100 early this year. It also topped out last month around 98 and has been unable to rally back to those previous highs. The tide is rolling out.
The stock market has also been giving us sell signals. For example, the Dow Jones Industrial Average broke below key moving averages last month and has not produced any meaningful rally. These are negative signals.
Since the 2008 collapse, we have seen this action in stocks and the dollar before. In those instances the Federal Reserve saved the day for the dollar and stocks with QE programs and other schemes that pumped newly printed dollars into the system. But this time is shaping up differently.
The Fed has not done anything of substance — at least not yet anyway. The rising selling pressure in the stock market is the result.
“These two markets are of course inextricably interrelated. We price the Dow Jones, S&P 500, and, for that matter, every individual stock in terms of the dollar. The dollar is the measuring stick by which market participants state their individual subjective view of the value of every stock. But valuations are less important now than the need for liquidity.
Because of all the leveraged bets, investors have had to sell stocks to keep their heads above water. But with prices in Asia heading lower to begin this week, a global slide in prices is the result.
It is noteworthy that the dollar fell yesterday along with the stock market. We are seeing a rush for liquidity as stocks head lower, but yesterday’s weakness shows that the dollar is losing its position as the currency of choice."
