Equity Strategy September 21, 2007:

The Federal Reserve sparked a rally in the global equity markets with the surprise 0.5% reduction in both the Fed Funds and the Discount rates. Investors took the rate cut as an indication that the Fed was not going to allow the problems in the sub prime mortgage market to impact on the economy and they headed back in to equity markets with a vengeance.

Lower interest rates hammered the US dollar which fell dramatically against most currencies including the Canadian dollar which is now at par with the US dollar for the first time since the summer of 1976. The US dollar appears to be in for a major tumble and could see substantially lower valuations going forward. There seems to be very little confidence in the currency and confidence is what has maintained the strong US currency over the past 2 decades.

There have been concerns expressed regarding the so called twin deficits, the budget and trade deficits, which have been escalating over the past 7 years at an unsustainable pace. The US now needs new foreign investment of between $75 and $85 billion monthly to cover these deficits. The vast majorities of those investments has been coming from Asia but as the dollar weakens those countries are likely to try and diversify their risks by adding Euros and other major currencies to their portfolios.

As the old saying goes “it takes buying and a lot of buying to push a market up, all it takes is a lack of buying for a market to fall”. That is the situation the US dollar is facing as investors look to other currencies in an effort to protect their purchasing power from erosion due to US dollar weakness.

The equity markets have let out a sigh of relief but I believe it a little too early to become complacent. I am willing to miss this first rally in order to wait for the next shoe to drop. The US economy is going to go in to recession over the next two or three quarters and when the psychology becomes so negative that the commentators on CNBC announce the end of the equity markets as we know them and that investors will never be able to make money in stocks again because the US economy is permanently broken, it will be time to load up.