The Dollar Destruction

As infamous trader Jesse Livermore used to say, “Conditions are ripe for a sell off.” The litany of global problems that exist seem to be compounding every day. As if the market doesn’t care, the major indexes have spiked up over the last few weeks. It does seem odd to see such strength under these circumstances.

This week however, trading started off the day quite positive but then gave back much of it by the close. Strength in the morning followed by weakness in the afternoon is usually a bearish sign. While the S&P 500 has been up three of the last four days, we‘ve had only a fractional gain this week.

Usually the start of each month and especially the start of a new quarter is a time for strength as retirement plans of every ilk get funded and new money flows into the market. With April’s monthly strength period now over, hardly a dent has been made towards a market advance.

The strong season for the market is also coming to a close. There is historical statistical evidence that gives credence to the “sell in May and go away” concept for period investing. While markets don’t have a calendar, the November through April timeframe historically has significantly outperformed the May through October period, and May is coming soon.

Investor sentiment is running high. The recent Investors Intelligence Sentiment Survey reveals that less than 16% of professional newsletter writers are bearish and over 57% are bullish. This Bull to Bear ratio of 3.65 displays even more optimism than at the market peak in 2007.

This survey has been widely adopted by the investment community as a contrarian indicator. Since its inception in 1963, the indicator has had a consistent record for predicting the major market turning points.

Another contributing worrisome factor is the coming end of the Fed’s Quantitative Easing Program (QE2). When the Fed stops buying bonds, monetizing our debt, and pumping billions of new dollars into our economy on a daily basis, how will the markets fare? That is a big question. Currently it’s as if the economy is cycling ahead with training wheels on. What happens when they come off?

Should markets correct on anticipation of or at the end of the QE2 money pumping machine, it would mean that a market top was occurring at almost precisely the same time it did last year, which included the Flash Crash.

One of the key factors that markets appear to be ignoring today is the ever rising price of oil. High oil prices have always led to a recession. Oil is a direct reflection of a falling dollar. With the ongoing destruction of the US dollar, caused in a large part by the QE2 program, commodity prices are going through the roof. Now is a time for caution.