Wall Street Weekly – The Dollar, GDP and Trendlines
By Robert Perrego, at 7:40 am on October 31st, 2009This week saw a lot of action upside and down. Monday, Amazon.com Inc. (NSDQ: AMZN) posted great earnings but it was not enough to hold the market up as the Dow traded down through, and closed, below a major trend line in effect since the bottom from March. The dollar has been part of the new carry trade and has established an inverse relationship with the stock market. Market players are shorting the dollar as interest rates are so low, and using this money to buy ‘risky’ assets. These risky assets include commodities, bank stocks and emerging market stocks. This has caused the market to drop on any dollar rally as participants that buy their dollar short in, lose those funds they go long the risky assets with, and therefore have to sell these assets. This causes selling pressure on the market.
On Monday the dollar rallied and the market dropped enough to close just through this important trend line. On Tuesday, the market did not move substantially but what it did do, without moving, is close for a second day through the trend line. A trend line break is something that gets traders attention, but a second close through is seen as a sort of confirmation that the first drop is not a false move. Tuesday, without moving, the market gave a minor confirmation with the close below the trend line.
Wednesday saw selling across the board in the market and a dollar rally. The Dow dropped 119 points and market gurus such as Bill Gross were calling a top. The Dow had now closed well below the trend line and the dollar, and its now well known inverse relationship with the stock market, had bottomed and was rallying. This was causing the carry trade cowboys to cover their shorts and sell out of the stock market.
It seemed that Thursday was a day poised for a loss. But, at 8:30 Thursday morning, the GDP number for Q3 2009 came out and beat by a sizable amount. After over a year of negative GDP numbers, the economy posted a 3.5% growth rate when the expected number of 3% seemed too optimistic to many. In fact, Goldman Sachs pulled their 3% estimate down to 2.7% on Wednesday which accelerated the selling. Goldman got caught with egg in their face as the number came in above expectations and the market was off to the races. The dollar dropped, which is counter-intuitive. A strong economy means a strong currency, but the carry trade and the amount of shorts in the dollar were so large that this regular linkage was broken. The dollar dropped and the Dow rallied for 199 points. The day was saved!
Friday came and the market got pummeled. Good earnings and a good Chicago number did not matter. It seemed that the trend had been broken, and, players afraid of the Fed meeting next Tuesday, did not want to be caught too short the dollar. The carry trade cowboys lightened up on their dollar shorts, sold their stock longs, and the market was hit for 250 points. It is likely most all the carry trade players still have dollar shorts, but they were considering their risk of being too short should the Fed issue hawkish statements. Worse yet the Fed could up interest rates, but that is widely not expected to happen.
Right now this whole market is teetering on the dollar in a backwards way from how it usually does. In the past, the yen was the low interest rate currency and used for the carry trade. This is no longer the case. It is the dollar, and should we get good economics news and the dollar rallies – it could actually hurt the market.
Welcome to 2009.
