KanalyBlog

Election Results - Another Positive for the US Dollar

In the wake of yesterday's stunning election in Massachusetts, why did the equity markets endure the steepest losses of 2010? After all, markets rallied on election day in anticipation of the Republican victory. CNBC's Jim Cramer used much of his show to urge viewers to "Buy, Buy, Buy!", based on his belief that gridlock will reign in Washington.

While most pundits are busy overstating the Democrats' loss of a filibuster-proof majority in the Senate, declaring health care reform dead and projecting massive Republican gains in November, the election did give rise to one potential outcome that has important implications for the markets. That is, voters have clearly rejected runaway government spending and huge budget deficits and bailouts, without regard to which political party is responsible. As a result, expectations of additional government stimulus programs and so-called "quantitative easing" by the Federal Reserve should be scaled back. In short, the Fed's printing press is now running a little short of ink.

So let's think of the investment implications. First and foremost, this is positive for the value of the US dollar and bullish longer term for the markets. Our leaders have steadily debased our currency and reduced our standard of living through the Fed's zero interest rate policy and our trillion dollar budget deficits. Any improvement on this front is likely to be met with a rise in the dollar, and in fact the dollar is up about 1.5% over the last two days. The chart below shows that the dollar bottomed on Thanksgiving and recently made a higher low. We think the dollar may move significantly higher.

One other major implication of less government stimulus is that the private sector economy must shoulder more of the burden. This is the handoff of the drivers of economic growth that we have discussed in recent months. After a liquidity-driven rally of near 70% in the equity markets since last March, investors are expecting solid growth in 2010. Perhaps today's market reaction, even in the face of good earnings news from IBM, reflects concern that growth may not be quite as robust in an environment of fading government stimulus.

Stocks Start New Year Strong, Jobs Not So Much

The calendar may indicate that a new year has begun, but one week into 2010, global equity markets continue to act like it is still 2009. The S&P 500 closed higher each day this week to post a 2.7% gain and close at the highest level since October 2008. On Friday, stocks reversed earlier losses stemming from the morning's disappointing report on December employment. As has been the case for some time, equity investors interpreted the relatively weak economic news as assurance that the Federal Reserve will continue its easy money policy, providing fuel for the ongoing market rally. So Friday's market action followed the recent pattern from such events: the US dollar declined, gold went up, and stocks rallied.

The December employment report was certainly a disappointment, especially to those who expected the economy to create jobs. Employment fell by 85,000 jobs in December, and revisions to prior months subtracted another 1,000 jobs (we've previously discussed that upward revisions to recent jobs data could be seen as an important turning point). The unemployment rate remained at 10% because the labor force contracted. Why did the labor force contract? Because when those looking for jobs become frustrated by the lack of job openings, they eventually stop actively looking for employment and the government removes them from the labor force for purposes of calculating the unemployment rate. A stark picture of the scale of this problem can be found below, which shows an acceleration in the number of unemployed people filing for emergency unemployment compensation, or those that have been unemployed for so long that they have lost state benefits (typically six months or more). As a result, the unemployment rate will likely remain stubbornly high even after firms begin to hire, as thousands of unemployed re-enter the labor force.