The Real Reason for the Rally

10/06/2010 9:49 am EST

Focus: MARKETS

Jack Adamo

Editor, Jack Adamo's Insiders Plus

Jack Adamo, editor of Jack Adamo’s Insiders Plus, says the weak dollar is behind this low-volume market rally, while the investing public remains on the sidelines permanently.

The main impetus for this rally is certainly not the economy, which continues to sludge through the mire; this rally is nothing more than a reflection of the rapidly weakening dollar.

The dollar is weaker, [so] it takes more of them to buy an asset. Hence, we have rising prices, also known as asset inflation—the same thing the Federal Reserve has been giving us since 1998. At some point, this breaks down.

Cycles of dollar weakness, punctuated by a little dollar strength, usually take three to six months, except in the case of the 2008 meltdown. We’re four months into this one, so we could easily have another two months to slide.

Still, it’s hard to ignore the economic data and the fact that ordinary investors are leaving the market in droves. There are those who interpret this exodus as bullish, saying that all that money “on the sidelines” is potential fuel for the rally when investors rush back into the market to avoid missing the boat. But I’m extremely skeptical about that view.

First of all, that money isn’t on the sidelines. When you add the money that came out of stocks and money markets and subtract what went into bonds, [a large amount] left Wall Street’s grasp entirely.

Where did it go? Commodities? Exchange traded funds? Uh-uh. ETF purchases show up in stock volume, which continues to scrape along at extreme lows. Maybe the money went to Vegas, where it has a better chance at the blackjack tables.

My interpretation is that the average investor has gone fishin’ and doesn’t plan on coming back into the market, period. That’s not to say he couldn’t change his mind if things settle down and there’s an extended rise with low volatility, but for now and the immediate future, I think John Q. Public feels (rightfully) that he’s playing against a stacked deck.

Volume since the May 6th “flash crash” is absolutely abysmal in the truest sense of the word, and with 75% of volume coming from [high-frequency-trading] computers, it’s like someone dropped a neutron bomb on the US investing community: The buildings are still standing, but all the people are gone.

In any case, while I firmly believe this low-volume rally cannot continue for anything like the 15 months the last time we saw this insanity (2006), we have to start pulling back on our hedges. We will probably replace them with gold, which should hold up if we have another sudden crash. We may add some foreign funds and stocks when we sell the hedges. They have much better long-term prospects than the US market. However, they seem overextended at the moment, and I’d rather wait for a little pullback, if possible.

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