How a Weak Euro Became Bullish
Stop thinking a strong dollar and weak euro is bearish -- it may actually be the best thing for the stock market.
-- Jonathan Swift
I've been listening to a lot of traders who seem to continue to hold onto the notion that a weak euro (FXE) / strong dollar (UUP) is bearish because it means it would not longer exist. I never quite understood why a lower euro automatically meant the currency would disintegrate. On the contrary, its becoming very clear that the forces of deflation are far stronger in the eurozone than they are here in the U.S., and that they need a weaker currency to import inflation more than we do. In the 1990s, a strong U.S. dollar coincided with a strong stock market, and we may be in the early stages of that type of relationship expressing itself all over again. Perhaps the most important aspect of this is that a strong dollar going forward likely outperforms U.S. Treasuries as money flows not into the bond market, but the new "safe-haven" of large-cap stocks which can absorb big money.
Take a look below at the price ratio of the Powershares DB Up Dollar ETF (UUP) relative to the iShares 7-10 Year Treasury Bond ETF (IEF). As a reminder, a rising price ratio means the numerator/UUP is outperforming (up more/down less) the denominator/IEF.
Notice how very gradually the dollar has been outperforming Treasuries since late August following the Summer Crash of 2011. The trend appears to be very early on, as dollars become more valuable to own than government paper at record low yields. What does this potentially mean for the "Winter Resolution" idea I've been writing about, whereby a trend asserts itself and the volatile sideways action of equities comes to an end (see From Fall Melt-Up to Winter Resolution)? If a rising dollar is bullish, it suggests that money may continue to move out of Treasuries and potentially into large-cap stocks which can absorb big sums.
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