In our last weekly review, we observed that the stock market action didn’t look like the kind of trading that we would expect to see in front of an economic slowdown or second recession. Well, it’s always good to challenge your premises, and data guru Greg Weldon is a fine challenger.
In his essay Time Loves a Hero Weldon presents the opposite case, as usual with numerous data points and fine charts. You should read the entire piece, but I will go to the conclusion for the sake of making my point here. His conclusion is that, unless the Fed fails to act as they have signaled, he remains a Dollar bear and a precious metals, commodities, emerging markets, and Treasury bond bull.
Lets take this from a couple of angles. First, assuming the investment thesis plays out as Weldon suspects, we will have the continuation of one of our macro themes: the US Dollar is driving all the markets. Readers know I have been looking for support around 76 in the Dollar index and a possible rally, and on that basis I am short gold. If 76 doesn’t hold, then the low 70s (2008-09 lows) are the next line of support. If those don’t hold we are in uncharted territory.
That type of event means continued weirdness in inter-market correlations, such as conventional bonds and TIPS and precious metals rallying together. That type of thing just isn’t sustainable over long periods, so we will have a situation where one or more of these asset classes is highly vulnerable to a serious correction.
A second angle we get from Weldon is in stocks. He shows the economy deteriorating sharply but stock market investors, taking their cues from the Fed’s continuing trashing of cash and shorter maturity bonds, are bidding up share prices. There we have the markets continuing to rally while the real economy continues to struggle. Whether that is sustainable in the long term is also doubtful…again leading to a situation where stocks are highly vulnerable to a serious correction.
Now back to my primary thesis: QE2 is largely priced into most asset classes. The US Dollar is falling and driving almost everything else up. Where Greg Weldon and I disagree is that he appears to think these trends will continue barring the Fed’s failure to deliver. My position on the other hand is that the market has already discounted the Fed and the trades are crowded, and whether the Fed acts or not, the trends are vulnerable to correction. Therefore I am hedged by being long select equities, and short the odd couple of gold and the long bond, based on my technical analysis of where the markets are most vulnerable at present. We’ll see what happens.