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Goldilocks Gets Botox


Perhaps, just perhaps, Goldilocks is not the spry ingenue some pundits proclaim...


There's an evenin' haze settin' over town
Starlight by the edge of the creek
The buyin' power of the proletariats gone down
Money's gettin' shallow and weak
Well, the place I love best is a sweet memory
It's a new path that we trod
They say low wages are a reality
If we want to compete abroad.

-Bob Dylan

Dollar weakness is anything but news. What is news is that despite the crowded trade, the downtrend remains remarkably persistent. Nary a spike to shake out the weak-handed and the faint-hearted shorts.

This, despite an underlying bid in the dollar, courtesy of the Chinese in order to prevent the yuan from lifting too much.

The greenback has been flirting with the 80 level – a level from which it has found support in the early 1980's and the early 1990's and once again in 2005. A break below 80 would violate these multiple bottoms carved out over three distinct test periods of that level, years apart.

And, you don't find many quadruple bottoms. You find many triple bottoms (and tops), but usually the fourth time through generates a new leg. I refer to a break of triple bottoms (or tops) as a Rule of Four Breakout.

Keep in mind that should such a signal be triggered, it would be a failure of a level that has been well tested and held on multiple tests over a generation.

What is more than interesting is that from 1995 to 2000, as the equity market advanced strongly, the dollar index advanced in tandem: the dollar index went from 80 to 120, precisely a 50% move; while during the same period, the S&P 500 advanced over threefold.

However, since 2000 the tables have turned, as the dollar has remained in a pronounced downtrend through a Bull and Bear equity phase alike.

What's wrong with this picture? The equity Bulls (economists, strategists, and technicians alike) want their cake and want to eat it too – they will take both sides of the argument twisting the stats to suit their assumptions (as Peter Drucker, the late management guru, said, "In all recorded history there has not been one economist who has had to worry about where the next meal would come from.") Going into the year 2000, a rising dollar bolstered the underlying value of U.S. assets – as the dollar rose, so rose the value of the underlying means to production in the U.S. And by definition so rose foreigners' capital as to U.S. assets when translated back into their own currency if repatriated. Additionally the Bulls argued that the rising dollar reflected demand for U.S. assets.

Since 2003, and particularly for the last two years, the Bulls' argument has been that a declining dollar means foreigners can purchase U.S. assets on the cheap. What's wrong with these two un-correlated views:

  • Rising dollar/rising U.S. equities
  • Declining dollar/rising U.S. equities

A cheap dollar makes the price of U.S. assets look cheap, but it reminds me of the story about the frog in the pot of water: turn the heat up slowly and the frog will stay put, complacent and convinced he's adjusting – until he's cooked that is. Take the same frog and throw him into a pot of boiling water and he will jump out and survive.

Let's follow this same thread with IBM for example. In theory, if the dollar had declined 50%, IBM would have to double just to get back to parity – to where it was before the dollar slide commenced.

To wit, a declining dollar has made the U.S. market look attractive and paints a pretty picture, to a point – but it is losing canvas quickly. The point is dulling quickly. At some point the scenario becomes a losing equation for a foreign holder: when the descent of the U.S. dollar outweighs the rate of ascent in the underlying U.S. asset, (say IBM for example), or the perceived ability to increase based on economic issues specific to the U.S., then an inflection point is at hand. Seems to me, there is a threshold approaching. Seems to me, the Rubicon will be crossed at 80 on the U.S. dollar index.

This inflection point coincides with the S&P flirting with a test of its all time high, at the same time as the printing presses are rolling overtime, minting botox for Goldilocks. Perhaps, just perhaps, Goldilocks is not the spry ingenue some pundits proclaim, as they cheerlead the idea that retail is going to rush in on a new Dow high above 13,000 taking the DJIA another thousand points higher. Now there's a momentum based argument if I ever heard one. I wouldn't underestimate the intelligence of the retail investor just a mere seven years after the 2000 top and the lessons learned therein. Hold up a mirror to the disconnect revolving around the dollar and it may look more like a picture of Dorian Gray. Writes Randall Forsythe of Barron's, "That this dollar merry-go-round cannot go on forever is at the core of the dollar Bears' argument. The massive U.S. current account deficit has to be funded, either through political contrivances or capital inflows."

The inflection point I see will be front and center next month when Treasury Secretary Paulson and Vice-Primer Wu Yi meet. Paulson wants a major increase in the yuan. Poor Henry. He thinks he has a genuine relationship with the Chinese based on feelings, but it is likely to prove nothing more than a cliché – an arrangement, where he's been buying time. If an egg is laid at this meeting, bring out the plum sauce as the chickens will come home to roost in Congress – in front of an election, politicians will reckon what's good for the goose is good for the gander and will cook up trade sanctions. And the Rubicon will be crossed.

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No positions in stocks mentioned.

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