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Is the market up or is the dollar down?


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I've been trying to make sense of the market moves over the last six months and it all seems to boil down to the question I posed above.


On the one hand you would expect prices to increase because the sentiment has shifted from pessimism to optimism and the V shaped rally narrative supported by fiscal stimulus seems to be playing out and the main beneficiaries of the rally are tech stocks who have seen their earning power enhanced by the shift towards everyday life and business being conducted online. So this could justify using pre-COVID earnings as an anchor (in the expectation of a fairly rapid recovery to those levels) and lower interest rates support the use of a generous P/E multiple.


But on the other hand there has been a lot of money printing and the money supply has expanded by over 20% since the end of last year and gold prices have increased by about 30% over the same period. So this raises the question as to whether the purchasing power of the dollar is a lot less which would obviously result in having to pay more $ for the same share of American business.


Of course both factors are probably at play but to what extent?


If dollar depreciation is the big factor driving markets then even if economic fundamentals deteriorate and a V shaped recovery turns into a W then there is a lot of support for stock prices and they could go even higher. And as the Fed has made it pretty clear that quantitative tightening isn't going to be on the cards any time soon that is another very bullish factor.


But if the market has gone up because of optimism about fundamentals then it would seem that if the recovery stalls or reverses and there are a lot of earnings disappointments in coming quarters then the market could be heading for a large fall no matter what the Fed does.





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