Sell US stocks and buy the dollar

However, even within a downtrend there can be countertrend rallies the same way there can be significant corrections within an uptrend. Right now the situation we find in financial markets is as follows. The US stock market and other stock markets around the world have risen from their late October lows in typical post election rallies.

However, it is quite common that these post election rallies fade out relatively soon, as was the case when Richard Nixon was elected in November 1972. This was followed by further strength but the stock market made its final high in January 1973 - slightly higher than in December 1972 - before entering a devastating two years' bear market.

Mid-December correction

Since, at present, the US and also other stock markets around the world have become significantly overbought amidst record bullish investors' sentiment it is very likely that either a top is already in place or about to occur within days, which should be followed by a correction of around 5% at the very least and lasting into mid December.

From a mid December low we should then get a year end rally into January, whereby I am expecting that numerous technical indicators will fail to better their current high readings. This should then lead to a more pronounced downturn into February.

It is, however, important to remember that whereas the US stock market is up by around 40% from its October 2002 low, in Euro terms it has hardly risen because the dollar has almost declined by 40% against the Euro since 2002. So if Mr Greenspan decides to carry on with his irresponsible monetary policies it is possible that in dollar terms the stock market will continue to rally but it would likely fail to move up much in Euro terms since more of the same Greenspan monetary policies, as he implemented in the past, would lead to an even weaker dollar.

As a side I may mention that the US economy is far from the 'New Economy' which was relentlessly broadcasted by the high tech apostles who led their investors into incurring devastating losses following the bursting of the NASDAQ bubble. In my opinion, the US economy increasingly resembles a 'Banana Republic' economy a la Latin America in the 1980s (the present US administration increasingly exhibits some similarities to dictatorial Banana Republic leaders as well).

At that time Latin American countries tried to cushion the end of the flow of petrodollars after 1980 by increasing their budget deficits and by printing relentlessly money. This then led to rising trade and current account deficits, hyperinflation and a collapse in their currencies as well as their economies.

The result was that in local currencies the stock markets rose throughout the 1980s, but that in dollars - then a strong currency - they lost 80% or more of their value. Needless to mention that Latin American local bond markets were in the 1980s' hyperinflation period a total wipe out! Therefore, if the US economy moves in character closer to Latin American economies, US bonds should now be sold.

Dollar over-sold

Above I mentioned that the US stock market is now - in the near term at least - in significant over-bought territory. The opposite seems to be the case for the US dollar, which has now reached an extremely over-sold position. I recently attended several investors' conferences and everywhere and from everyone I only hear US dollar bashing and that the US dollar will decline further.

As a contrarian this makes me skeptical since usually universal bearishness leads to rallies while universal optimism leads to disappointments. Moreover, while I certainly agree that in the long run the dollar is going to be totally worthless in terms of its purchasing power, and that a cup of coffee will eventually cost US$100 or even more, I am not so sure that the dollar is now over-valued against the Euro.

Quite on the contrary, from a recent trip to Europe it is my impression that at the current exchange rate the dollar is - purely on its purchasing power compared to the Euro - somewhat undervalued. As a result, I think that the most likely financial developments in the next few weeks will be a setback in US equities and a rebound in US dollars.

In particular, I should mention that numerous large currency and commodity funds have huge leveraged dollar bear positions outstanding, which could rapidly be unwind once the dollar begins to rally. I suppose that if the US stock market could decline within a long term uptrend by 21% in one day - this happened on October 19th 1987 - the US dollar could easily rally by 5% to 10% within a short period of time.

There is one more point to consider. Whereas the dollar may continue to depreciate in value it may not depreciate much further against the Euro but against other assets such as precious metals and the Asian currencies.

In this respect it is also important to realize that whereas the gold price has moved up against the US dollar, it has been steady against the euro since 2002. In other words gold has moved up largely on the back of US dollar weakness but is certainly not expensive in euros, or compared to the S&P 500 and to oil.

When gold is expensive compared to oil it takes more than 20 barrels of oil to buy an ounce of gold. This was the case in 1984, 1994 and 1998 (one could also say that when it takes more than 20 barrels of oil to buy an ounce of gold, oil is very inexpensive). Conversely, when gold is cheap compared to oil - as is now the case - it only takes about 10 barrels of oil to buy an ounce of gold.

Not owning gold a risk

Therefore, I would feel more comfortable to own gold right now than to pile into, in my opinion over-valued Euros. Still, even gold is now somewhat over-bought and if we are right about a US dollar rebound, then gold could easily correct to the downside over the short term. However, as I have mentioned before, there is a risk of not owning any gold and silver at all, since we do not know how much more irresponsible US monetary policies will become in future in an attempt to bail out a basically bankrupt system.

Also, rather than buying Euros at this point, I would buy Asian currencies for the following reason. While the Euro has appreciated significantly over the last two years against the US dollar, the Asian currencies have by and large not moved much since the Chinese RMB is pegged against the US dollar and the other Asian countries do not wish to have their currencies appreciate against the RMB for fear to lose their competitive position in export markets.

But if the Euro should rise against the US dollar much further, Asian monetary authorities and especially the Chinese will come under increasing pressure not just from the US to revalue but also from the Europeans since the Euro would become significantly over-valued against the Asian currencies.

As a result of the Euro strength Chinese exports to Europe are already soaring and there is no doubt that in time the Europeans are going to take the Asian to task for having forced the Euro up and for eroding their already weak economies even further. As a result, I think that to buy some Asian currencies (but not the Hong Kong dollar) does make sense.

Personally, I like - as mentioned on previous occasions - the Singapore dollar, but now I would also buy the Malaysian Ringgit, since like the RMB it is also pegged to the US dollar. Compared to the Euro, the Singapore dollar is a tremendous bargain and from the charts we can see that a breakdown of the US dollar against the Singapore dollar is a distinct possibility.

Bearish on US bonds

Lastly, we should mention that US bonds are unlikely to provide satisfactory returns in the years ahead. Without or with less support by Asian central banks, US bond prices are likely to decline and if the US dollar remains structurally weak inflation is likely to accelerate. Therefore, we feel the time has come to liquidate US bonds.

In sum, and for the short term only, I would now get out of equities and buy the US dollar. If for diversification purpose or in order to join the US dollar selling panic another currency than the dollar is absolutely necessary, then I would buy gold, silver and the Singapore dollar for the reasons outlined above.

For the longer term, we shall need to assess the extent of the US stock market correction, as we may already be at or very close to a major top. The same may apply to the over-bought Euro compared to the US dollar. As for US bonds, the likelihood of US interest rates moving up is high and, therefore, the reward of holding dollar bonds does not appear favorable compared to the risk.