Stages of the dollar

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Quotable

First witch: When shall we three meet again,

Second witch: In thunder, lightning, or in rain?

When the hurly-burly’s done,

When the battle’s lost and won.

Third witch: That will be ere the set of sun.

First witch: Where the place?

Second witch: Upon the heath.

Third witch: There to meet with Macbeth.

First witch: I come, Greymalkin!

Second witch: Paddock calls.

Third witch: Anon! All: Fair is foul, and foul is fair:

Hover through the fog and filthy air.

                             (Macbeth, Act 1, Scene 1) William Shakespeare quote

FX Trading – Stages of the dollar

Maybe some of you have been receiving the same email I have been getting; it says the market will crash sometime between Thursday, September 17th and Monday, September 28th. I haven’t delved into the details of the prediction, and probably wouldn’t understand them if I did. But, with today being quadruple witching and all, I thought I’d share that warning.

Of course we are seemingly in the midst of a crash already, if you define your terms accordingly, it is the crash of the US dollar. But have we reached the climax stage? Probably not, as it seems the US government is playing the benign neglect game and liking how a weak dollar is juicing the US stock market—can you say wealth effect?

Thinking in terms of stages, below is repeat of a piece we wrote several moons ago that lays out the stages of the dollar. It’s a framework that can likely be applied to any currency and any asset market in general. If you’ve pinpointed exactly where we are in the dollar cycle, please let us know. Thanks.

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Seven Stages of the Dollar

It’s always difficult to pinpoint where we are in terms of a trend. Long-term trends in the currency markets have ranged from six to ten years, measured by the various bull and bear markets in the dollar since the inception of the free-floating currency market back in 1971. Here’s the pattern of long-term bear and bull markets in the dollar as measured by the US $ Index:

1971-1978: Seven-year bear market (President Nixon closes the gold window closed)
1978-1985: Six-year bull market (Fed Chairman Volcker squeezes inflation)

1985-1992: Seven-year bear market (Triggered by the Plaza Accord)

1992-2001: Ten-year bull market (Tech boom and money flow to US assets)

2001-2008: Seven year bear market (bottom on the credit crunch)

2008- ? : Next major bull market?

No one can say when multi-year bull and bear markets end without some perspective. But we can evaluate conditions as they develop that may indicate the potential for a change in the big trend. I use the boom/bust cycle of price action to help put this longer-term moves into some type of perspective.

The dollar, especially from a longer term perspective, moves in waves—discernable waves based on human emotion and supported to differing degrees by the underlying economic fundamentals at various stages along the way. It sounds complicated but it’s not. Here’s an example of the waves or stages of the dollar in a boom/bust price cycle…

  • Stage 1: The unrecognized trend – This is the early on stuff. It represents the beginning of a new trend that is recognized by only a few of the major players.
  • Stage 2: The beginning of a self-reinforcing process – This is the stage where the consensus begins to realize there are real underlying fundamental reasons why this “new” trend has legs. This is the most powerful and longest leg or wave of the trend.
  • Stage 3: The successful test – This is the pull-back that challenges the consensus view, it represents a significant retrace of the prior wave “self-reinforcing” wave. In the case of the dollar, the bear market correction we witnessed during 2005 is an example of a “successful test.”
  • Stage 4: The growing conviction, resulting in a widening divergence between reality and expectations – This represents the last major leg or wave of the trend. It is supported by real fundamentals or expectations of how the fundamentals will play out, but it also represents the stage in which the currency is either “overvalued” or “undervalued” on a pure fundamental basis.
  • Stage 5: The flaw in perceptions – This is the stage in the cycle when some of the major players begin to realize the currency cannot be supported by the fundamentals, as highlighted above.
  • Stage 6: The climax – This is the final stage of the move, and represents the “overshoot” we often see in currency markets because they tend to be more sentiment driven and price-led than other asset markets.
  • Stage 7: A self-reinforcing process in the opposite direction – The trend begins in the opposite direction.

So where are we now in terms of this dollar major bear or bull market?

For help, we paraphrase Joe Kennedy, former stock manipulator and SEC Chairman (things really haven’t changed much on the regulatory front have they ), when shoeshine boys start playing the FX market and all know the dollar is dead, and are making a killing short the dollar, it’s time to go long. That’s when you know we are very close to Stage 7, time to start looking in the other direction.

I think I’m going to have my shoes shined on my next trip, which is next week. I will keep you posted.

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