With all the excitement that continues to swirl around the announcement of the Federal Reserve’s latest monetary stimulus plan, equity and commodity markets are off to the races this morning. Gold, in particular, is catching a sizable bid as bullion prices are up about $40/oz. (3.0%) this morning. And while these early prints are no friend to my personal portfolio, I have to revert back to a point I made yesterday. As is the case almost any time we get significant news from the Fed, the trading days subsequent to the announcement are usually volatile, which makes determining the intermediate trend much more difficult. And that’s exactly what I think is going on today. Odds are that we won’t begin to see the market’s ‘real’ reaction to this stimulus until next week as the short term momentum players begin to move to the background and more institutional money is put to work.
That said, it is entirely possible that this euphoria could prove to be sustainable for some time. The Fed’s willingness to intervene as needed is a comforting idea for most investors. This assumes, of course, that the benefits of additional actions outweigh the associated costs, which is highly suspect at this point in the recovery process. But as the Fed continues to expand the money supply and raise the perception that inflation is coming, weakness in the U.S. Dollar and rallies in all major commodities are logical outcomes that are beginning to materialize today. The bigger question, though, is whether or not these trends can continue apace in light of the moves that were seen in the month leading up to yesterday’s release? Equities, as measured by the S&P 500, have rallied nearly 17% since September despite continued sluggishness in the domestic economy. Can a rally of this scale and speed really be sustained in such an environment? It’s possible, but I just don’t see it as probable. Same goes for gold. The rally in the yellow metal has been nothing short of relentless. And while it is perfectly logical that investors would flock to gold as a way hedging Dollar-devaluation risks, the likelihood of the rally continuing after a truly historic run of late is limited in my opinion. Again, a sustained rally is possible, just not probable in my view.
One of the more significant developments today has been the selloff in the U.S. Dollar Index (DXY). Sure, an expansion of the money supply is normally a negative development for any currency. And with the Fed explicitly stating its intent to create more currency, the pressure on the DXY is an expected reaction. But as I’ve noted on this blog several times over the past few weeks, the DXY has, until this week, continued to hold trend line support on its weekly chart. This suggested to me that while sentiment towards the Dollar remained negative, there was enough bullish sentiment to keep it from breaking support and testing the 74.25 level. With today’s break below the 76 level (the low trade for the current move), the door is now wide open for the DXY to test 74.25. And while this development is certainly a setback for Dollar bulls (myself included), the fact that critical support lies a short distance from current levels suggests, to me, that the DXY has more risk to the upside over the intermediate term. Just as I wouldn’t be an equity buyer in here given the scale of the recent rally, so too would I not be a seller of Dollars due to size of the recent selloff.
To be sure, remaining cautious in a market environment that keeps moving higher is a tough place to find myself standing. There is not a day that passes that I don’t sit and ponder whether or not my primary thesis is incorrect and that I’m missing something critical. One of the primary concerns I’ve had, corporate earnings, has proven more resilient than I originally thought would be the case at this point in the year, which has softened my negativity toward equity somewhat (though the S&P 500 still sports a rich trailing twelve month P/E ratio of 18). But that fundamental development aside, the scale and speed of the recent rally coupled with the domestic economy’s need for additional monetary stimulus at this point in the recovery cycle still points to an environment that is full of potholes than opportunities. The next few trading days will be painfully confusing to weather, but, thankfully, rationality should begin to return early next week. Whether or not this rationed trade coincides with the move lower I’m expecting remains to be seen.
Until later…..
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