What a Weak Dollar Really Means for Emerging Stocks
Bad news and data have hit the market during the last few weeks. Let me summarize the ones that I consider most important:
• The Obama administration raised its projected 10-year budget projection deficit to $9 trillion from $7.1 trillion, a “measly” 27 percent miscalculation in just one year. The real deficits will probably be much bigger. These deficits do not take in consideration the Medicare and Social Security liabilities, which would increase deficits to gargantuan proportions.
• Colonial BancGroup went bust and revealed that its loan portfolios were worth on average 37 percent less than stated in its books. Delinquency rates are averaging 7.8 percent and the charge-off rates at 2.65 percent. This suggests that behind the accounting games and handouts from TARP, the situation for the banks is getting worse and that they face heavy losses.
• Unemployment has reached 9.7 percent and the U-6 statistic, which includes discouraged workers, rose to 16.8 percent. Job losses keep rising. Government forecasts projected that this year unemployment would reach only 8.9 percent, thanks to the stimulus packages. These levels have been clearly breached. Also, the unemployment levels are higher than the maximum estimated for the bank “stress tests.”
• Consumer credit contraction keeps rising, decreasing in July by $21.5 billion. The downwards trend in this statistic is in place and at an accelerating pace. It seems that the consumer won’t be back any time soon. Growth in the United States, upon which approximately 70 percent of the economy rests, will be at best very muted.
All these factors, plus a very overbought condition in the market after a 50 percent run from the bottom, makes me expect a substantial correction. During the last few weeks we got a couple of fast and strong selloffs but the market recovered its bullish trend quickly and seemed poised to make new highs.
I also thought that, despite the negative economic data for the U.S economy, the dollar would have a corrective bounce. During the last 12 months there has been a strong inverse correlation between stocks and the dollar. When stocks are weak, the dollar gains strength and vice versa.
The dollar index has remained very oversold during the last several months and sentiment was extremely negative towards its future performance. Bad economic data and selloffs in the stock market were the perfect excuse for the dollar to rally as investors flock to “safe haven assets” such as the greenback.
Despite this, the dollar remained under pressure and just ground sideways in conditions under which it would have normally rallied. In the meantime, commodities held to their gains and had minor corrections.
The dollar couldn’t stage a recovery, even though it had many factors at its favor. Now, with the stock market regaining strength, the dollar index is continuing its sell off and broke support at the 78 area, making new yearly lows. The dollar looks very weak, and it seems that the only factor that could make it increase in value is another financial crisis.
Given the economic data I highlighted above, this would seem likely. However, governments around the world will do anything in their power to prevent another deflationary spiral. This week the G-20 pledged to continue their efforts to refloat the world economy by mantaining deficit spending, low interest rates, and expand the money supply.
The United States, being the leader in the application of these policies, will keep on printing money, bailing out failed companies, and increasing fiscal deficits in order to throw money into the ailing economy.
In this scenario, the dollar will keep falling toward new, historic lows, commodities will rally, and stocks will rise, with emerging markets outperforming. Even though economic data and conditions continue to deteriorate, equity and commodity markets can keep their upwards trends thanks to the continued market intervention and aggressive monetary policies of governments and central bankers worldwide.
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