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.

Comments

[joe]

Say your right. How high do you see the Dow going?

Joe

[yelnick]

Joe, the simplistic view is the Santa Rally runs about 25% of the whole year. Dow started at 8800 and began Santa Rally at 10236. A 25% of year rally is 1/3 up from there, or around Dow10700. A ~500 pt advance. At the outside Dow11.2K, the 62% retrace. A ~1000 pt advance. My bet would be on the modest bounce.

[Rich]

There are quite a few people worried about this market, people who have profits they'd like to lock in but who'd rather not get hit for capital gains on them on their 2009 returns.

I think the next wave down begins Monday, January 4, 2010.

[joe]

They would just hold - as you suggest.

But for the people that did already make trading profits - they will sell their losers now to offset the gains they already made. This market went up alot - I am guessing their are an awful lot of short term gains and the tax selling to offset them could get "intense" IMO.

Joe

[Michael]

390,000 Calls traded on the UUP today in the contract months of January and March. Meanwhile, only about 3,300 puts traded on those same months. Hmmmmm...

[joe]

I would also note about tax loss selling - most of it should be next week. After that, many people will be taking off for X-mas vacation - I think.

[Cary Lloyd]

Not a lot of losers to sell! This has been an extraordinary ferocious bull! So profits will be taken in January, so people can at least keep the float anothet
year.

[joe]

"Not a lot of losers to sell!"

Depends on when you bought it, isn't it? The world didn't start anew in March.

If you had trading profits this year - short term capital gains (ordinary tax rates)- and I am sure there are many people in that category - they will seek to offset those gains and "dump losers." Bet on it.

Joe

[Cary Lloyd]

Joe, I think that the vast majority of shareholdings --whether the purchases were last week, last year, last decade, or in 1958-- represent gains. Taxable gains. Now I know there are some people are still underwater in some positions. But those are the exceptions. Without a doubt, most long positions are net winners. But they won't be forever and there are many people who know it. So the selling starts January 4 so they can keep the float in the bank for a year or play the short side or wait for a much lower reentry.

[Cary Lloyd]

p.s. The Japanese market topped in January ('90 was it?) for this very reason.

[mannfm11]

Borrowing and spending dollars is one thing. Getting them back is another. Expect a crash soon.

[joe]

The problem is that gains made during the year are ordinary. If you can't wipe out the gain with a loss position - it means maximum tax rates (if your in the max bracket)- in California its about 45% (fed and state). SO if you have a loser position and sell it in the year the ordinary gain was made - its like getting back half of the loss.

I am a tax accountant and I'll just tell you - maybe 1 out of 5 questions I am getting this last month are about the above.
And I tell them - it is a chance to get about half of the loss back.

I really wouldn't kid yourself about most long positions being winners. I assure you, there are many many capital losses sitting out there. Many people seem to hold losers and pray they come back.

Last year after the wipe out - the opposite situation arose - very little tax selling because almost no one made a profit trading at all.

Joe

[Diamond Jim]

The market has a well-known penchant for frustrating expectations. Just when everybody is calm and reassured and ready for Santa cheer the boom could fall. The key remains the dollar. While the market has shown in the past that it can rise with a strong dollar, the situation is different today. The carry-trade has created a situation that cannot support rising equities in the face of a sharp rise in the dollar. The short squezze of the century could suddenly drive stocks down if panic sets in with the international traders.

[Michael]

And thus far, given the recent new-found strength in the Dollar... the "carry" trade has yet to have any noticeable or significant impact.

[Milen]

Presently it looks like a bottom is in as the other pairs are ahead of the curve with the EUR/USD looking like its going to start to push lower. Price will need to confirm this idea:
See my chart at: http://oneelliottwavetrader.blogspot.com/