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January 23, 2006

Dollar Crush

Dollar aficionados who were writing about an impending bounce in our currency will have to seriously rethink their strategies after today's slump. The US Dollar Index was walloped for over 1%, breaking decisively into new downside territory since the current slide began in November. The slide also impedes the bulls' chances of reviving the stock market at this juncture.

I'd like to use today's dollar action to answer a reader's question about the correlation between the dollar and the stock market. Rather than post the message in the Q&A section, I'll answer it here so I can offer more detail. The question is why stocks should go down when the dollar goes down. After all, wouldn't flooding the system with dollars drive the dollar down while inflating stock prices? The answer is yes, in the long run that will be the case. In the short or intermediate-term, what matters most to stocks is psychology, and for the passed 18 months or so, the dollar has been an important concern. Traders currently view the decline of the dollar as representative of the decline of U.S. power, and therefore every time the dollar trends up or down for a time, stocks follow.

Of course, the dollar has been declining ever since the creation of the Federal Reserve in 1913, so why does its decline suddenly matter to stocks? Well, things go in cycles, and 2004-06 is not the first period that the dollar's decline has affected stocks. (It mattered in 1987, for example.) The questions we need to answer are how strongly the dollar still matters (will it be as tight a correlation as last year?) and how long the correlation will last. Those questions can only be answered by persistent observation, and I will continue to post my thoughts on the matter.

Back to today's action… gold and silver were curiously tame in light of the dollar's weakness. However, I've consistently espoused the idea that regular correlations are nearly meaningless on a day-to-day basis. More than likely, metals traders are simply hesitant after the 10%+ run we've seen in the last 5 weeks. If the dollar holds down or falls further, it will play very well into my expectations for a continued spike in PM prices.

As for equities, bears did not have to suffer a rebound today. Bulls were initially blaming Friday's sell-off on options expiration, but if that were true, we would have seen strong buying today. I wonder what excuse they will use next. Given that we did not see buying and that the dollar is weakening, I would place higher odds on a continued sell-off in coming days.

Intel continued to have the hurt put on it today, falling another 2%. With the latest slough in its share price, Intel is now selling at 3.4 times sales and 15.5 times TTM earnings. I imagine we'll see a slew of wannabe analysts start proclaiming Intel a turnaround stock since the shares have not seen such "low" valuations in over a decade. However, Intel is a company in crisis. It does not enjoy the near-monopoly status of its past. Market share and margins continue to be pressured by AMD's advances, and it is only a matter of time (days or weeks, I think) before Dell relinquishes its Intel-only status. Given prospects of negative growth rates in coming quarters, the stock still seems downright expensive to me.

Friday produced two newcomers to my open trade signal list, putting shorts on Circuit City and Netlogic Microsystems. I have been looking for points to get short on more retailers, so I opened a put option position on CC today. However, I refrained from trading NETL due to the fact it reports on Wednesday. Fred Hickey, the ultimate tech stock guru, panned NETL in this week's Barron's Roundtable (an excellent read, by the way). His short call makes resisting this signal very difficult, but I tend to refrain from opening positions just before earnings announcements, especially when I haven't done my own, extensive research on the company.

The next two days should tell us a lot about the importance… or lack thereof… of Friday's sell-off.

Disclosure: Short INTC; Long INTC, CC Puts


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