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By: Costas Bocelli — August 31, 2017

Could This Be The Market's "Wonder Drug?"

 

 

Right now, the stock market is sick.

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Although over the medium- to longer-term term, Mr. Market is still considered relatively healthy.  But in the near-term, he’s definitely caught a nasty cold.

The question is, will this turn into something a lot more serious?  Or can the market shake the bug simply by getting a little bed rest and staying hydrated?

An outside view of the market, the view you get by gauging, say, the S&P 500 index, shows a rather encouraging longer-term prognosis.

For example, despite the S&P's having in August posted its worst monthly loss this year... it has still managed to maintain trend line support above the 200-Day Moving Average.

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It's the inside view of the market that could be a cause for concern.

You see, since the beginning of August, market internals have been weakening.

At True Market Insider, we break-up the U.S. stock market into 41 narrow industry groups.  This allows us to see the inner workings of the entire market on a more granular level.

And over the past four weeks, our breadth indicators have detected that supply has taken control over the majority of these groups.  This is the development that’s causing us to see red flags everywhere.

In a sense, the major stock market averages are being propped up by just a few mega-large cap stocks like Apple (AAPL).   This in turn masks what’s really going on.

In last week’s conversation, we continued that theme, and dissected the Sector Breadth Bell Curve.  We said that, with so many sectors showing supply in control, a more defensive posture should be taken.

Weeding out securities demonstrating poor relative strength is a good way to raise cash which can then be redeployed into stronger-performing securities when market internals improve.  Or, if you're loath to hit the sell button, tightening stop-loss orders could be a more palatable defensive measure.

Buying protective put options and selling covered calls on existing positions are other actions that can be taken to mitigate risk.

Hopefully this "preventative medicine" is enough to fortify the portfolio should Mr. Market’s nasty cold turn into something more like pneumonia.

We also mentioned in last week’s article that a Trump a tax reform bill would almost certainly restore positive strength to the market internals.

And although the White House and Congress continue to say all the right things, actually getting a bill passed remains a daunting challenge, especially when government seem to be in such a state of flux.

But there is one "miracle drug" that could return the market to health -- a weak U.S. Dollar.  You see, since the beginning of the year, the U.S Dollar Index has been on a steady decline, down about 10% from its recent high.

And earlier this week, the U.S. Dollar Index hit a fresh two-and-a-half-year low, a level not seen since early 2015.

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Here are 3 reasons why a weak dollar could be just what the doctor ordered.

A weakening U.S. dollar generally benefits large U.S. multi-national companies because it makes exports more competitive.  This in turn boosts revenues and profits.

Through the first six months of the year, U.S. companies are generating the highest profit growth in six years.  And if there's such a thing as "chicken soup  for the market", it’s strong profit growth.

By the way, corporate profits are expected to grow by low double-digits in the current quarter.

(Rising profits, driven by a weaker U.S. Dollar, can serve as a powerful antibiotic)

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A weaker U.S. Dollar generally increases commodity prices.

Global Central Banks are doing everything in their power to boost price inflation -- things like "zero bound" (or even negative) interest rate policies and quantitative easing programs.  But they've found it very difficult to push prices higher.  However, we’re already seeing the effects of a weaker dollar, which could help move inflation higher over the coming months.

Just have a look at copper prices, which have gained 25% year-to-date.

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Gold, aluminum, coal, iron ore and steel are all moving higher too.

If the U.S. Dollar continues to weaken, the reflation trade may just be getting started.  That in turn should be good news for risk assets, like stocks and commodities.

And finally, a weakening U.S. Dollar has been great news for developing countries such as Brazil, India, Russia and China.

You see, in many developed economies, a significant number of loans are denominated in U.S. dollars instead of in local currencies.  So a weakening dollar actually makes debt repayment much easier, which reduces financial stress and boosts economic growth.

Also, with the U.S. Dollar the world’s primary reserve currency, the movements of it can have profound implications on not only the domestic markets, but globally.  In fact, one of the biggest beneficiaries of the weakening dollar has been Brazil.

Have a look at the iShares MSCI Brazil ETF (EWZ).

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After a political scandal rocked the market in the spring, the Brazilian stock market quickly regained its footing and is now moving to new 2017 highs.

If that old saw is true -- that when the U.S. catches cold the world sneezes...  then perhaps a weakening U.S. dollar will also provide the cure.

Until then, a defensive posture is still indicated.  A high priority for investors is to pay very close attention to the breadth indicators.

We’ll keep you apprised of the situation in upcoming issues of True Market Insider, so stay tuned!

Until next week.

Costas

P.S.: You can find out more about Profit Skimmer here.

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