Saturday, November 25, 2006

Is the Dow in a Bull or Bear Market?

Magicians are quite clever: they pull the audience's attention to their right hand and then do the "magic" with the hidden left.

Markets aren't so different. While our attention is drawn to the numerator--the price change of an equity index such as the Dow--the real magic is occurring in the hidden denominator.

That hidden denominator, in the case of the Dow, is the dollar. U.S. stocks and indices are measured in dollars. But the dollar itself is a moving target.

And it's been moving down.

Denominated in dollars, we have the magic of Dow 12,000.

Denominated in British pounds, the Dow has only recovered a tad more than half of its 2000-2003 decline.

Denominated in gold, the original hard currency, the Dow has been in freefall and only recently recovered from multi-year lows.

So how much of the bull market has been Dow strength (vigor in the numerator), and how much has been dollar weakness (a plunge in the denominator)?

At the very least, judging from the red line, at least half of the Dow's strength can be attributed to weakness relative to other currencies. The Dollar Index chart I posted recently makes that point far better than I ever could.

But bullishness in the Investor's Intelligence survey is at an annual high. Watching the right hand, we celebrate Dow 12,000. Meanwhile, no one mourns what's happening in the left hand.

Magic, indeed.