The Summer Rally Was an Illusion

08/17/2010 12:00 pm EST

Focus: MARKETS

Jack Adamo

Editor, Jack Adamo's Insiders Plus

Jack Adamo, editor of Jack Adamo’s Insiders Plus, says the market is softening after the recent run-up, and the rally’s low volume showed its underlying weakness.

I strongly believe we are headed back into a recession or at least a period of such slow growth for the next few years, that the market is going to take back much of the gains of the last 16 months.

Indeed, there’s a lot of support for that view. Despite the strong rally in July, [the Standard & Poor’s 500 index is] well below the late April peak, and the rally has been on very light volume, which is always suspect.

The inverse relationship between price and volume also continues to hold true, as does the long-term down trend in the number of advancing issues. But what I missed lately is the big change in the dollar trend.

The dollar has been plummeting since the first week of June. The reason for this is that recent economic data, as well as Federal Reserve Chairman Ben Bernanke’s own remarks, make it clear the Fed will have to keep its monetary easing policy in place for the foreseeable future, cheapening the dollar.

During the big run-up we saw in 2004 to 2007, I pointed out a number of times how the rally in stocks was actually just a manifestation of a progressively weaker dollar. In terms of any stable currency, the market hadn’t moved at all and never made the new highs Wall Street claimed.

In other words, it wasn’t that companies and the economy were any stronger in absolute terms; it was that their value expressed in dollars was higher because the dollar was worth so much less. We saw the same thing in commodities.

Of course, that ultimately doesn’t make sense. The market is going up because the dollar is getting cheaper because the economy is weakening? These aberrations go on for only so long.

It’s a traders’ market, and the volume is very light because it’s the summer and because the retail investor continues to pull his money out of the market. Another $1.3 billion and $3.8 billion left mutual funds in [a recent two-week period]. When the hedge funds and investment bankers tire of trying to pick each other’s pockets, we’re in for a nasty fall.

That said, the market [had] been very strong [until recently].  I’m reluctant to drop my guard, since I think the reverse will be swift and severe when it comes. Things may begin to unravel towards the end of the month when Greek debt faces [the International Monetary Fund’s] scrutiny. We’ll have to wait and see.

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