The Fed & Weak Dollar Investment Trap

Written by Dennis Slothower
Posted January 26, 2018 at 7:00PM

With the OTC index annualizing since the first of the year around a whopping +270%, it only follows it is a pace that is beyond sensibility, even for the central bankers rigging the market.

The S&P 500 is about 13% above its 200-day moving average, one of the widest spreads in history.

We see this being represented in the ADX (Average Directional Index), which registered a new historic peak at 70.

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You can’t help but wonder at this historic level what the most likely direction will be from here. The previous record was at 56 — and this chart goes all the way back to 1900. All of these swings have spiked back downward, so we can’t help but conclude the market is at the apex of statistical abnormality.

The stock market indices continued to eke out further gains led higher by big technology companies in historic extremes. While traders focus on the Amazons and Googles driving the market indexes higher, underlying risk continues to press like a hidden cancer.

That might sound a bit dramatic but with yields rising, the U.S. operating cash flow growth (liquidity) ex-financials and energy continues to slow.

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What this means is more and more companies are seeing their liquidity disappear. If you remember, when Lehman Brothers fell apart it was because of liquidity issues. When monetary policies continue to press banks and they taper their lending dramatically, this negatively impacts the cash flow of businesses.

This suggests a big surprise is coming in the next few quarters, and yet, most people don’t see it. They are blind to it. In fact, people’s appetite for risk has just set an all-time record.

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Cash levels have never been as low as they are at present. The herd is fully invested and as they continue to buy, the real question is who is selling? The public isn’t selling. So who then is selling?

It is an easy answer... it is the investment banks that are unloading en masse ahead of further interest rate hikes to come. Remember, at the bottom of a recession when fear is the greatest, everyone is selling.

But who is buying then? The investment banks are buying. They buy on fear.

When optimism is the greatest and the public is demanding stocks in overwhelming greediness, it is the investment banks that unload their stocks. They sell on optimism.

The investment banks are masters at stoking greed. For example, it has been five months since the last 2% correction. It has been 15 months since a 3% correction and it has been 19 months since we’ve seen a 5% correction.

In other words, just before the economic cycle peaks the market is financially engineered to make it look like you can’t lose. This builds a manic frenzy in the market... yes, an irrational exuberance.

Then out of nowhere — selling suddenly develops — from great extremes that people have been ignoring.

I like making profits as much as the next guy. But it is one thing to make paper profits. It is another thing to keep real profits.

Crashing Dollar: Good or Bad?

I can’t stress enough the profound effect the crashing U.S. dollar is having on all the markets at present. We have seen one of the worst starts for the dollar since 1987 and the dollar was hammered again this week.

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The deeper the plunge in the dollar, the more oil prices ratchet higher, and the higher oil prices rise, the more inflationary pressures build. The other side of the coin is that while the dollar plunges, the rest of the world’s currencies are skyrocketing higher, especially the euro.

It follows that the deeper the dollar discounts the more dollars it takes to buy things. So the government can give us all a tax cut, but take it all away again in making us pay more for things should inflation spike in a crashing dollar environment.

Speaking at the World Economic Forum in Davos on Wednesday, Treasury Secretary Steven Mnuchin said the U.S. is open for business and welcomes a “weaker dollar”, saying that it would benefit the country.

“Obviously a weaker dollar is good for us as it relates to trade and opportunities”, Mnuchin said, adding that the currency’s short-term value is “not a concern of ours at all.”

There was immediate blowback over the comments.

President Trump had to say Mnuchin was misinterpreted about the dollar and that the U.S. ultimately wants a strong dollar policy. The dollar should now start to rally on this. It's an old Goldman trick; say the opposite of what you really mean.

Consequently, the U.S. dollar rallied Thursday, only to start sliding again Friday.

Bear in mind, the dollar has collapsed about 10% despite the Fed raising interest rates three times in 2017, and it has been in free fall mode this January, causing some to be unsettled by Mnuchin’s attitude at undercutting the dollar.

Well, it may not be a worry to Mnuchin but a plunging dollar brings significantly higher gasoline prices in the springtime and that means a big surge in inflation, which itself means higher interest rates to come from the Federal Reserve.

This is why the bond market has really struggled the last six months, especially so with the attitude of weak dollar currency trade wars.

Simply put, when inflation spikes because of a plunging dollar, Treasury yields spike too. When Treasury yields rise, bond prices fall. Undercut the dollar too much and the bond bubble bursts, with a recession that isn’t far away.

Good For Gold

As the U.S. dollar has been plunging this has been great for the gold market, which is now challenging its September 2017 highs.

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As long as the dollar continues to plunge gold will continue to surge because of the perception of building inflationary pressures caused from heavy discounting of the dollar — 10% over the last 12 months.

Add in the perception of the tax cuts and growth, and gold is suddenly a real contender now — especially with Bitcoin having lost some of its luster recently.

What is working against gold and really all the capital markets is the Federal Reserve, which is working to tighten monetary policy, having raised rates five times. And if it follows through with its plans, we are looking at two or three more rate hikes in 2018 at least.

Gold, the bond market, the stock market, all the markets run into trouble when bond yields invert (i.e., short-term interest rates become greater than long-term interest rates) and liquidity dries up.

When that happens the economy will shift from seeing inflationary pressures to deflationary pressures build, as a recession begins to rear its head and investors will be scrambling to get out of vulnerable assets in search of safety.

To your wealth,

Dennis Slothower Signature

Dennis Slothower
Editor, Stealth Stocks Daily Alert and Wall Street's Underground Profits

Dennis Slothower has been leading a small but profitable group of investors to some extraordinary profits in both good markets and bad over the course of a 38+ year investment career, starting as a stock broker in 1979. In 2011 Dennis was named the top performer by Hulbert Financial Digest for avoiding the Crash of 2008. Now, he is bringing his extensive experience to the public through Outsider Club, Stealth Stocks Daily Alert, and Wall Street's Underground Profits. For more about Dennis, check out his editor page.

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