charleshughsmith

Contributing editor Charles Hugh Smith notes that markets are at an important inflection point. The direction things take from here may likely be apparent within the next few days.

As I noted in my previous exploration of the U.S. dollar and the technical evidence for a long-term uptrend in the dollar index DXY, global markets for stocks, commodities and currencies are on a simple see-saw: On one end is the U.S. dollar, and on the other are all other major currencies, global stock markets, commodities, etc.

The U.S. stock market has been recently surging on hopes of a comprehensive settlement to the European debt/banking/euro crisis. Technically, this surge exceeds the recent trading range, and thus is seen by many traders as a valid breakout; i.e., the signal a new Bull market is underway.

This aligns with the views of many experienced technical analysts, who expect a strong rally to start from here and last into early March.  The reasons many expect such a rally, despite the headwinds of global recession, are seasonal and cyclical: Stocks almost always rally strongly in Nov.-Dec., and the third year of the presidential cycle (2011) is generally positive for stocks. In addition, various timing tools and indicators can be interpreted as supportive of a major rally from this point.

A much smaller number of analysts (including Chris) see increasing probabilities of a global stock market crash.

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II – The Technical Argument for a Stronger Dollar

In Part I, I raised the potentially heretical possibility (at least to some) that the U.S. dollar, as reflected by the DXY dollar index, might be in a multi-year uptrend, and then endeavored to sort through the psychological underpinnings of resistance to this possibility.

Here in Part II, I will lay out the technical case for the DXY’s possible multiyear advance.

I would like to start by addressing correlations. Given our minds’ predilection for pattern-matching, it’s natural to see correlations between two slices of the market. For example, when the DXY rises, the stock market declines. This correlation invites speculation on reasons that would explain the correlation.

As the saying goes, correlation is not causation, and so while this line of speculation might illuminate some hidden causal dynamic in play, it also offers ample opportunity for distraction and misguided conclusions.

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II – Positioning Yourself for the Devolution of the Euro

One of the clichés of investing is, “There is no bad investment; there is only bad timing.” While we all know there are indeed bad investments, the point about timing is still valid: In certain situations, timing is the difference between a good and bad investment.

The European crisis may well be just such a situation. Until the structural imbalances are truly resolved and not simply papered over for purposes of perception management, then investments denominated in euros will remain at risk.

If the systemic flaws are not resolved, a risky investment (i.e., assets held in euros) could become a disastrous one. If the imbalances are eventually addressed on a structural level, assets denominated in euros or the follow-on currencies may become relatively attractive.

For investors, the key characteristic of the Eurozone crisis is its unpredictability. Anyone claiming there is “zero probability” of a Eurozone breakup is indulging in false precision. Nobody knows what will happen, as the E.U. and the euro are unique experiments without easy historical precedents. All that can be said with any certainty is that toothless reforms, empty compromises, and ballooning bailouts cannot fix structural flaws, and those are essentially all that’s been offered to date.

Despite the unpredictability of the Eurozone’s debt and currency crises, we can sketch out one potential timeline which would suggest an evolving, flexible investment strategy.