I want to take a look at three indexes, and their impact on the stock market. The three indexes are the Dollar, Commodities, and the Bond market.
Dollar: The dollar has been falling since 2002. On February 18th, 2004 the dollar fell to a 9 year low of $84.77. Since oil is priced in dollars, when the dollar declines, oil becomes more expensive to consumers. Recently, the dollar has rallied sharply from its oversold position which caught many investors who were short by surprise. Hedge funds and other professional traders went running to cover and hence the dollar put on an impressive performance to the upside. The renewed strength in the dollar has fueled optimism among foreign investors, and these investors began to put money back to work in US stocks.
If the rally in the dollar is truely an oversold reflex bounce, then foreign investors will take profits near the upper end of the S&P's trading range (around 1250). Many experienced investors believe the dollar is in a long term downtrend which could last another 5-10 years. If the dollar resumes its downtrend, this is what we could could expect.
1) Foreign investors will take profits. The stock market will sell off, and oil prices will continue to climb.
Commodities: The commodity index as measured by the CRB index has fell sharply due to profit taking. Market guru's like Jim Rogers believes that commodities are in a longer term bull market, and others want you to believe that commodities have put in a major top. I have to side with Jim Rogers. To believe commodities have put in a major top, you also have to believe that growth in China and India have reached the peak. As is the case with oil, commodities will continue to be in great demand as China and India continue to grow. We are still in the early stages of this expansion. Could this market cool for a while ? Of course, but continued growth is all but assured.
When the CRB Index begins to bounce back we can expect:
1) Renewed and real inflation.
Bonds: Last summer the 10 year Treasury had a yield of 4.9%, and the 30 year Treasury was yielding 5.6%. Since then, the Fed has raised the Fed Funds rate 200 basis points and the 10 year and 30 year are yielding 3.9% and 4.2% respectively. Many believe that the decline in interest rates have added stability to the stock market despite higher energy prices.
Lower long term rates have also added fuel to the overheated real estate market. Recently, Alan Greenspan made comments about a selective bubble that exists in the housing market. Greenspan obviously disagrees with the markets bet that longer term interest rates should remain low. One of three senarios could play out here:
1) Greenspan agrees with the bond market and stops raising rates.
2) Greenspan disagrees with the bond market, and continues raising rates which further inverts the yield curve.
3) The bond market realizes they were wrong, and investors begin to sell bonds driving longer term interest rates up.
Since so many people (particularly NASDAQ type real estate speculators) have differing opinions on the subject, the only question that remains is this. How much are you willing to bet?
