The Big Picture

Dollar Disconnect ?

Thursday, May 08, 2003 | 10:58 AM

I know you were planning to disconnect me, and I'm afraid that's something I cannot allow...

How is it that the dollar is in freefall, Bonds are steady, and equities are up? Why the disconnect? The inter-market relationships between these asset classes seem to have (temporarily, at least) vanished; Bonds and equities tend to move in opposite directions at the same time. Equities and the US dollar – at least in the ‘90s – had a high degree of correlation. Lately, these assets have gone off on their own ways. Here are a few thoughts as to why:

Bonds: Steady bonds may be reflecting a fear of deflation; Perhaps the fixed income market is pricing in yet another rate cut; Add some ill-timed chasing by retail (with yields at 40 year lows), and that may explain some of the recent action. I wonder how many individuals switched to Bond funds in their IRA/401(k), making monthly contributions; Could this be sufficient to offset the asset allocations of Funds away from fixed income and into equities? Perhaps. Regardless, expect this to end badly.

Market Technicals: The internals of the markets haven’t looked this good in quite a long while: Maybe it’s a case of “been down so long it looks like up to me.” The number of stocks near 52 week highs are up, and trending higher; A/D line is near its year high; Major indexes are above their 50 and 200 day moving averages.

By most technical measures, the equity markets are healthier than we have seen in a long while. That doesn’t mean we aren’t overbought, or susceptible to a pullback (we are); Indeed, with bulls now up to 55.8%, and bears down to 24.4%, sentiment is reflecting that the market has gotten ahead of itself. But the technical picture hasn't been this nice in quite a long while.

Earnings: have been coming in much better than expected, and this is somewhat misleading as to the overall health of the market. You may be startled to learn how much Energy companies have impacted earnings gains (See: First Call) of the S&P500: With 21 of 23 energy firms reporting, estimated earnings growth for Q1 2003 is up an astounding 180% - that increase is making S&P500 earnings look much better as a whole than individual sectors actually reflect. At least as far as other sectors are concerned, this has not been as terrific an earnings season as the total number suggests.

Back out energy, and this would have been a disappointing reporting season. The spike in Oil during the War may have led to a one time, windfall profit growth. This is worth watching, as it’s a potential danger sign going forward.

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