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rising dollar is bullish for stocks!...

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MARKET UPDATE
For Investors Seeking Returns at Lower Risk April 1, 2005
Stocks Are Bullish
While the market trend may appear to be aimless, it
is in fact building a base for a resumption of the
uptrend. As we mentioned in previous newsletters,
the market evidence has indicated that there will
indeed be a final blow-off rally to this major rising
phase that began in October of 2002.
Based on the typical average dimensions for similar
past trends, this advancing leg could have a peak in
the vicinity of 11,500 on the Dow Jones Industrial
Average and 1350 on the S&P 500 Index.
Naturally, the actual peak could be higher or lower
than these levels but these are a reasonable estimate
of a normal expectation.
The Dollar Trend Reverses
The most significant event of the last several weeks is
the change in the price trend of the U.S. dollar from
weakness to strength. As you can see in the chart
below, the last three years has been a virtually
unbroken succession of lower highs and lower lows
in the dollar index. Now that has changed and the
very strong implication is that a major reversal has
occurred that should lead to a period of relative price
strength lasting for several years. For the immediate
future, this initial strength in the dollar is an
additional bullish factor for U.S. stocks.
That is the good news. This change has, in turn,
several further implications that are not so positive.
For example, a strong dollar will increase the price of
everything we export and will aggravate our already
record-setting trade deficit. It is also almost a given
that this strength in the dollar will be accompanied by
rising interest rates.
The Impact Of Rising Rates
The market has had mixed emotions over the Fed
decision to raise the fed funds rate another quarter
point to 2.75%. The uncertainty was not really due to
the expected rate hike but over the Fed keeping the
“measured pace” language in its reference to future
rate decisions.
Some expect the fed funds rate to be around 4% by
year-end. Even after seven interest rate increases by
the Federal Reserve, the financial markets have still
not accepted the fact that there is now an environment
of monetary tightening. Even though the U.S. bank
prime lending rate, a mostly short-term gauge, has
risen to 5 ¾% the much longer term 10 year Treasury
is still yielding only about 4.5%.
Moreover, bond yields may rise to a level more
attractive to foreign investors. This will in turn drive
dollar buying. And the expectation of this will drive
immediate speculation on the dollar.
The combination of potentially higher returns on U.S.
equities and a rising dollar is apt to scare a lot of
money out of foreign investments back into the U.S.

Investors speculating on foreign companies might be
surprised to see their returns reduced significantly by
the unfavorable change in exchange rates.
At some point, the markets will have to accept the
reality of this tightening but for now this is probably
helping to prolong the positive trend for stocks.
Large Cap Stocks Should Lead
Over the past 40 years, we have seen that large cap
stocks tend to be the best relative performers during
the final phases of major bull markets. This seems to
be a function of tardy investors, including the big
institutions, who are in a rush to deploy the ir capital
into the market and simply find the superior liquidity
of the larger stocks most attractive. Since the market
is now in a very mature phase, we are currently
putting the heaviest portfolio emphasis on the large
cap segment.
A Serious Peak Is Still Ahead Though
While a rally in the dollar is bullish over the short term
and should help provoke several months, or
more, of further market strength, the ultimate impact
will be negative. In fact, a spiral of the rising dollar
and rising rates could easily get completely out of
hand and create the most drastic type of economic
trouble.
It is still to be expected that there will be a major
stock market peak at the conclusion of this next rally
phase. For the reasons that we have outlined before,
investors must be prepared to deal with a serious
plunge following that peak.


MELT-UP TIME!!!