Everything in the economy for the last couple of months has become optimistic. Stock markets are higher, manufacturing declines have stabilized and last week’s employment numbers give some hope that the US economy is on the recovery road. However, all may not be well in the world’s largest economy. Taking a look at the finer print, the economic turnaround so many have been supporting may actually be hitting a plateau. This nascent macro pessimism may be what the bullish dollar trader is calling for as fundamental factors may help boost the US dollar’s fortunes in the second half of the year.

Valuations Too High

First and foremost, stock market valuations have risen too far, too fast. Since the market hit the 12-year low in March, a short 5 months ago, the Dow Jones Industrial Average has risen by an impressive 40 percent. The broader S&P 500 is even higher, knocking on the door of a 50% gain since then. Forgetting the technicals of the market and looking at fundamental pricing, the higher price tags paid by the most optimistic in the market has forced valuations of stocks comprising the indexes to be inflated. According to recent reports, the valuation of the S&P 500 as a whole has jumped to a whopping 17 times earnings. In comparison, this valuation overshadows a more recent 15.4 times earnings trade in the supposedly riskier realm of the MSCI Emerging Markets Index. Simply put, stock prices are too expensive and will likely give plenty of reason for portfolios to be selling out of US assets. The same sentiment helped to spark US dollar buying last year. As the credit crunch crippled global stock markets, currency traders began buying up the greenback on a safe haven tip. The bounty of transactions were combined with overseas assets converting and selling out of riskier US assets and into US Treasuries. Result: What is bad for the overall stock market is great for the greenback.

Employment: False Hopes

According to the most recent non-farm payrolls report, US employment prospects have turned up a bit in the month of July. Although the market saw a rebound in the unemployment rate, proponents for a better tomorrow didn’t take into account other more structural figures. Taking a closer look, the number of people who have been unemployed longer then six months now account for a bit more than a third of all unemployment. Sector hemorrhaging also continued with just the same sector improvements seen in the last report. Ultimately, facts remain facts. Employment continues to weigh down the economy as there seem to be less and less job opportunities in the country. Result: What is bad for the US economy is great for the greenback.

Where have all the buyers gone?

Higher unemployment will continue to feed further tightening in consumer spending. Retail sales in the US on a week by week basis continue to be disappointing as retailers see slightly less negative numbers as signs of improvement. Retailers saw a 5.1 percent drop according to the Thomson Reuters’ survey. Gap saw an 8% decline while Saks witnessed a 16% drop in purchases. Moreover, consumers are likely saving more as pessimism has fed into depressed confidence. Recent figures point to a 7% US savings rate even as the debt burden per individual has risen sharply. Shockingly, according to the Federal Reserve, US households spent $1.20 for every $1 they made. Ultimately, unless households begin to massively deduct debt from their balance sheets, the propensity to save will be greater in order to maintain some sort of daily stability. Result: Less consumer spending is bad for the US economy, which is good for the US Dollar.

Commercial Conundrum

According to a recent assessment of the financial system bailout by the Congressional Oversight Panel, banks continue to remain strained as balance sheets continue to show retention of the so called toxic assets. Although the current administration’s bailout attempts have been relatively successful, the plan hasn’t totally eliminated the problem. Financial institutions are still holding residential and commercial loan derivatives which may cause further problems in the near term. Particularly, commercial loan topics have become en vogue as loan defaults doubled in the last 12 months. This situation is worrisome for the smaller banks with local shops continuing to boast the actual whole loan rather than the simple derivative. As a result, a higher rate of default may trigger another domino effect of failure and drag the markets lower, similar to drawdowns seen in the tailend of 2008.

Market sentiment of an economic turnaround does remain healthy. However, taking a deeper look at some of the figures that matter, the inevitable rebound will be a bit longer in the making as investors may have to contend with another wave of downturns which are likely to spur rapid US dollar bullishness.

Tags: Greenback, Non-Farm Payrolls, US Dollar

This entry was posted on Tuesday, August 11th, 2009 at 9:43 pm and is filed under Currency Trading, Discussion, US Dollar. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.