Stock Market & Dollar

The recent stock market boom is a symptom of excess liquidity caused by government policies. The liquidity is supposed to be injected into the real economy, but instead it is causing asset bubbles. The premise of the stock market rise is a falling dollar. Recently sentiment of the dollar has become so negative that a correction is over due. However, the government has no sign of monetary tightening, so it is fair to expect the dollar to resume its fall and stock market continue to rise.

Several scenarios are possible that would strengthen the dollar and depress asset markets:

1. Another financial crisis, may it be commercial real estate or credit cards defaulting. This would cause another liquidity crunch. (very likely to happen).

2. Global economies fail to recover. This would cause “flight-to-safety” and all the hot money flown to emerging markets will come back. (fairly unlikely)

3. Increasing opposition to Obama’s spending spree. The failure to pass healthcare and cap-and-trade would mean less money printing and less deficit, which are the causes for the dollar devaluation. This might actually be bullish for stocks. (fairly likely)

4. the Fed shows plans to raise interest rates and signals monetary discipline. In my opinion this won’t happen until employment starts to recover. (fairly unlikely)

If your investment has a long term horizon, then don’t worry too much about the coming correction. With all the structural problems of the U.S. economy, dollar is destined to fall much lower in the long term and stocks would be a fairly good hedge. Though as to diversify, it would be wise to own some gold and foreign stocks and bonds.

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