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A Rebound for Stocks and the Dollar?

07/02/2008 12:00 am EST


John Bollinger

President and Founder, Bollinger Capital Management

John Bollinger, editor of Capital Growth Letter, says stocks may be ready for a short-term rally as commodities correct and the dollar firms.

In our view, the broad stock market topped out in the summer of 1998, and we are completing the eleventh year of a sideways/consolidation market. Although there is very little data, it seems that the expansion/consolidation cycle is very roughly 16 years a leg.

Ten years in, it looked like the cycle was ending. Everything seemed set up perfectly, and it was hard to imagine what would occur to prolong the cycle for another six years. Then the mortgage crisis bloomed, spread into a systemic problem and set the stage perfectly for an extension of the cycle. The summer of 2013 will mark the 16th anniversary of the consolidation, and it is now easily possible to imagine this consolidation running for at least several more years.

Battling inflation with higher interest rates and tighter money supply, never a happy circumstance for stocks, is almost certainly the agenda for the foreseeable economic future. Already we see the signs of a slowing money supply and rising interest rates.

From a technical perspective, interest rates of all maturities are now in well-defined up trends, and we expect them to remain in this state for the foreseeable future. Given the high levels of inflation currently embedded in the system, a long bear market for bonds would seem to be in the cards.

In the past, stocks have liked the initial phases of interest rate increases and inflation has also been benign as long as it wasn't seen as being out of control. Interestingly enough, this fits pretty well with our view of a stronger, but highly volatile stock market into the election and then a transition to a more challenging environment for stocks.

Looking over the energy complex, considering price levels, alternatives such as coal, reduced consumption, reduced driving in the US, modern exploration techniques and so on, we simply can't see why prices should be sustained at current levels.

In fact, though the long-term outlook for energy is quite bullish, I think that the current price levels are most likely unsustainable and that a substantial correction may be in the offing.

Just as I am worried about energy prices being unsustainable, I am starting to worry about commodity prices. Speculators are also very active in this sector and a substantial disruption is a distinct possibility. However, there is no sign of technical deterioration yet, so it looks to be earlier in the process than energy.

The dollar is flat against the euro since mid-March and sitting in the lower portion of its recent trading range. During this same period the dollar has strengthened considerably against the yen and the Canadian dollar since the panic lows when a US dollar fetched but 90.5 Canadian cents.

Virtually everyone believes that the dollar is still falling, so perhaps the stage is set for a real reversal. We believe that the Federal Reserve will have to follow the European Central Bank and start raising rates, which might be the excuse to generate some strength [in the greenback].

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