Market Reaction to Jobs Report Confirms S&P 500/US Dollar Index Ratio Downtrend

On the surface, the US stock market's reaction to Friday's strong jobs report appeared neutral on balance by the end of the day. With expectations of the Fed raising interest rates in December higher than ever, real estate, utilities, oil, commodities, consumer staples and retail were down a lot, but financials were up a lot and technology was up a little, and in the end the S&P 500 only moved down by a single point.

But the bearish long-term trend of the S&P 500 underperforming the US Dollar Index, which I pointed to last week, was confirmed and underlined by the market reaction to the jobs report. The dollar soared on the expectations of a December rate hike, with the US Dollar Index rising +1.19%. So the S&P 500/US Dollar Index ratio made a sharp move downward, breaking well below its 200-day moving average after spending a few days this week above it:

In fact, this ratio did almost the exact same thing on the two previous occasions that it briefly broke above its 200-day moving average earlier this year, at the market peak in May and again in June:

Three days seems to be about the limit for the S&P 500/US Dollar Index ratio to flirt with a break above its trend line, before it reverts to its long-term downtrend:

The trillion dollar question, of course, is how this trend will affect the market itself going forward. After all, this downtrend has lasted over 16 months now, but the S&P 500 itself remains less than 2% off its all-time high. Ironically, even as the surging strong dollar has hurt the competitiveness of US-based multinational corporations exporting goods overseas, in a way the strong dollar seems to have propped up the stock market: The dollar has been so strong that the market has been able to follow the trend of steadily underperforming the dollar and still not fall significantly.

We now face a situation where the Fed appears to be almost compelled, by market expectations and by its own statements of its intentions for the past year and a half, to raise rates in December to preserve its own credibility -- unless something drastically negative happens to the world economy or financial markets between now and then.

Personally, my gut feeling is something drastically negative will happen in November or December, something like a repeat of the August global financial market volatility or worse. Things have been playing out almost too good for the Fed lately, too good to believe that they will last. The October market rally and the strong October jobs report have created apparently Goldilocks conditions for the Fed, where it looks like it will be able to raise rates without the move coming as a nasty surprise to the market, and without the expectation of the move sparking a big market sell-off.

A perfect situation for the Fed! Now all they need is for nothing to go wrong for six weeks. So, my gut tells me, something probably will go wrong. As I wrote last week, the S&P 500/US Dollar Index ratio stalled out about a year in advance of the market crashes of 2000 and 2008. It stalled out again last year. Was the August market correction really the worst that is going to happen in 2015?

Of course it is also possible that the next six weeks will be quiet, the Fed will raise rates, and only in 2016 will the negative effects of the rate hike play themselves out and cause severe problems in the economy and in financial markets. The strong dollar is one aspect of a massive global deflationary trend, seen most clearly in the collapse of the price of oil, copper, and other commodities in the past 16 months. A Fed rate hike will only exacerbate this already very troubling global trend. This cannot end well.

The question of whether bad things will happen in the market in 2015 or 2016 is a big deal if you are shorting the market and trying to time your shorts to maximize your gains. (I am trying to do this, to a modest extent; I may or may not succeed, even if all of my analysis is correct.) But for the vast majority of people, an economic downturn in 2015 or 2016 is bad news either way. We may have a happier holiday season if the financial reckoning of the global deflationary trend is put off until 2016 or even 2017, but we may come to regret our holiday spending if the chickens come home to roost in the new year.