NEW YORK (AP) -- Stocks rose Friday after another weak report on unemployment added to expectations that the Federal Reserve will step in to prop up the economy. The Dow Jones industrial average climbed above 11,000 for the first time since early May.
High unemployment remains a major hurdle as economic growth continues to be sluggish. The Labor Department's report, considered the most important piece of news on the economic calendar, did little to alter the view that the economy remains weak.
Investors are saying : the economy is weak but that is good for stocks because it means the Federal Reserves will have to print even more money. Someone in the comments section reminded me not to underestimate liquidity....that is precisely how I have been looking at medium term moves in the market....liquidity drives it. However, the longer term picture is not so sanguine. Bernanke's (helicopter Ben as he is sometimes known) money printing is very risky, because inflation can bring as much misery as a weak economy and you may end up with both a weak economy and runaway inflation.
In my last stock market update[Link], I wrote:
"The market is indeed running up to a peak from end Jul to Aug 2010 and I expect pretty good gains in the near term."
I expected the market to peak in end Aug 2010. For market watchers, you will know that is not the case and I was wrong - all part of the hazards of the inexact science of forecasting stock markets. The market after a brief but sharp correction Aug run up all the way in Sep 2010 and was still going up as of yesterday. For those who think that it is because the US economy is doing better, companies are making more profits and global economy is looking up that we are seeing this rally. ....think again.
The red line shows the Dow Jones Industrial and blue line the EURO/USD exchange rate.In the 1st cut, it looks like a highly correlated lock step movement. However, if you look more closely, you will notice the exchange rate movements lead the US stock market slightly. The other thing that is very clear is the US economic recovery is weakening[Link] as seen from a broad number of indicators. Like I mentioned in my previous posts, Singapore stock market is outperforming because of favorable allocation to emerging markets - thanks to countries like Indonesia, the Indonesian stock market is hitting all time highs. What is actually going on is the weak US dollar is holding up markets ranging from gold, oil, commodities to emerging market stocks. The US stock market bottomed on 26 Aug 2010, when Ben Bernanke announced on 27 Aug that the US Fed is willing to print more money[Link] (known as QE2), the US dollar weakened and stocks around the world rallied. This new printed money or promised printed money is what threw my forecast off. This "weak dollar" trade [Details here Link] in which traders borrow US dollars cheaply convert them to other currencies to invest in risk assets is self reinforcing - it further weakens the US$, push up assets to which liquidity is flowing which in turns encourages traders to borrow more US$ in a self-reinforcing cycle. Although this results in big trends (up) for risky assets, what happens at the end of the day is large built up of short US$ positions, highly leveraged positions in various assets. The large short position in US$ can result in abrupt short covering and deleveraging of other assets sometimes known as "de-risking". The rule of thumb is the longer the markets rise due to this weak dollar trade, the more abrupt and deeper the falls are.
Under the above situation, the longer the markets rise, the riskier things becomes but the psychology of investors is such that they perceive risks fading and take bigger risks. It is not clear how far the current rally will go, but I feel is can get nasty when the whole thing reverses. Printing money cannot be a panacea...somebody is paying as Bernanke debases the US$ - this is an old trick[Link] going back to the time mankind used salt and sea-shells for money.