The Four Horsemen of 2010

Evaldo Albuquerque (January 26, 2010)

What will bring about a Financial Apocalypse this Year?

Back in early 2008, I remember a colleague of mine predicting the impossible.

He said the U.S. dollar would rally hard…and that it would rally before the end of the year. He was laughed out of conferences, ostracized by colleagues and generally looked down upon as the dollar sank for most of the year.

Loyal A-Letter readers – having spent the better part of a decade buying gold and diversifying away from the dollar – were among his most ardent skeptics.

But then the “impossible” actually happened – as it does more often than you might expect – and the dollar rallied.

In a flash, he took down an unbelievable string of gains. 1,000% winner after 1,000% winner, he had a multi-month string of incredible winning trades by shorting emerging market currencies – the forex “weakest link” – in the face of a rapidly rising buck.

Now; in 2010, we could see a repeat. Here’s what would tip it off…

Basically, there are three major rally triggers I’m watching right now. Should any of these events take place – setting off the trigger – we could see a dollar rally spark off in a matter of hours or days. And the impact these trigger events have on the global economy could determine the intensity of a dollar rally, and the size of the overall gains we’ll be able to take down…

Trigger #1: Dollar & Stocks =
Jekyll & Hyde…only which one is which?

To truly understand the implications of a stock market correction, you have to hear about the recent, unusual relationship between the dollar and stocks. For most of last year, the dollar and the U.S. equity market moved in opposite directions.

The reason?

Whenever traders heard good news about the U.S. economy they sold off the dollar and piled back into “risk assets” – including U.S. stocks. When traders heard bad news about the greater economy, they sold off stocks and rushed back to the dollar and U.S. Treasuries for safety.

As you can see in the chart, the Dollar index (blue line) has recently resumed its decline, while stocks, measured here by the S&P 500 index (red line) are making new highs.

As the Dollar Falls, Stocks Rise and Vice Versa

The dollar remains a mirror image of the stock market. In other words, when the dollar falls, stocks rise and vice versa. And make no mistake, at times of economic and market stress, this correlation tends to intensify. So if we see a correction in the stock market, we will see a dollar rally.

Right now, there are plenty of clues pointing to a stock market correction.

From a basic price perspective, stocks around the globe are looking very expensive, especially in emerging markets. Almost every equity market around globe is breaking new highs.

Also, surveys are showing record low levels of pessimism. In other words, the vast majority of traders are positive about the market.

When everyone turns positive about the market…it spells trouble for the economy. It means everyone is buying, and soon they’ll be taking profits. They just need a reason to start selling.

But what can trigger a significant correction in stocks and uncork a major dollar rally? Frankly, there are plenty of hidden catalysts that could spark the next stock sell-off.

Let’s take a quick tour around the globe to see what’s going on. And why not start right here in the good old U.S.A…

Trigger #2: You Haven’t Forgotten
about the U.S. Housing Market, have You?

In the U.S., the housing sector remains the main threat to the greater economy and to stocks.

The government has been working double-time to keep mortgage rates as low as possible to entice new buyers back to the market. But that can’t last forever.

In fact, politicians have already announced that they will soon end the programs to keep mortgage rates down. When that happens, we will see a spike in rates when foreclosures are still mounting.

So that will almost certainly send house prices back in decline.

The Fed also said that it will use a “wait and see” strategy after these programs end before acting. They are saying if rates climb too far, too fast, they will consider reinstating the programs.

Frankly, this “wait and see” approach will just spark major uncertainty in the markets. That could shake the confidence in the global economy, and cause a stock sell-off.

Trigger #3: Eurozone…or just plain old Eurotrash?

Europe is definitely the best candidate for the next global risk event (and the next stock sell-off). In fact, there are so many problems in Europe that I’m just going to summarize them quickly…

• Consumers Who Refuse to Spend: The entire Eurozone is still plagued with consumers who won’t open their wallets. They also have rigid labor laws, so unemployment has NOT adjusted to lower levels of economic activity.
• E.U. Banks Still Won’t Lend: And remember that in Europe the banking system is a much more important source of funding than in the United States. So the European credit crunch will considerably slow down any recovery.
• PIGS Swimming in Debt: The PIGS (Portugal, Italy, Greece and Spain) are all MAJOR threats to the EU’s stability. Any one of them could spark a stock sell-off if they default on their debt (what they own investors for their government bonds).
• EU’s Version of AIG: Right now, Greece is by far the best candidate for a sovereign debt default. According to the Euro membership, all members must keep budget deficits below 3% of GDP. Greece’s budget deficit is more than four times that limit. And the numbers may be much worse. E.U. officials are citing “severe irregularities” in Greece’s statistical data, so it’s impossible to tell how much debt they really have. (Sound familiar? It’s just like AIG.)

Remember, it only takes one event to scare all this optimism out of the markets. Any one of these countries defaulting on their debt could be enough to tip the scales.

And if stocks plummet, the dollar will rally. In fact, this rising turbulence in the Eurozone will be extremely beneficial to the dollar.

Trigger #4: Chinese Miracle…or Chinese Hoax?

While the Eurozone struggles with sluggish growth, China has the exact opposite problem. The Chinese are facing too much growth…

It’s like driving a car at breakneck speed. If you suddenly have to stop, you better be wearing your seat belt. This year, China may have to tap on the brakes for the first time in months.

China implemented a massive stimulus package to jumpstart the market in early 2009. That stimulus ignited an incredible rebound in economic activity. But this unprecedented liquidity and credit expansion already points to inflation, and asset bubbles in the near future.

Chinese authorities have already started to lose control of the massive capital flowing through the economy. And the government knows that. Chinese leaders recently surprised the markets by increasing bank’s reserve requirements to try to reduce loan growth.

But they will have to do much more if they don’t want to lose control of inflation.

If China falls behind the curve, they may just have to slam on the breaks suddenly. When that happens, the whole world better buckle up, because we’ll all be in for a rough ride.

Again, this is just ONE reason we could see stocks fall and the dollar rally this year.

Hoping for the Best…Preparing for the Worst…

As you can see the global economy is not as healthy as it looks.

There are triggers lurking all over the world that could spark a stock market correction. If even just one of these events happens this year, stocks will fall and the dollar will rally.

You don’t want to be caught as one of the little guys unaware when this happens. Later today, you’ll receive my special e-mail report explaining the prospects of a dollar rally in more detail. Make sure you don’t miss it. Till then…

Best Regards,
Evaldo Albuquerque
Editor of Exotic FX Alert

P.S. Don’t miss out on the biggest dollar rally of the year. Get all the details on how to play this coming stock market correction and dollar rally in my latest report.

Tags: Currency