What Does The Drop In Unemployment Mean For The Dollar & Euro? (UUP, FXE, UDN, VGK, SPY)

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January 15, 2012 12:53pm NYSE:FXE NYSE:UDN

JR Crooks: The decrease in December’s unemployment was better than expected. And in the past, such drops became the fuel behind risk-appetite rallies.

For example, here is a chart below showing how the S&P 500 (NYSEARCA:SPY) began rising in the mid-70s when unemployment fell before eventually spiking again to more than 10 percent:

Assuming today’s investors are as optimistic about the unemployment figures as they were back then, we could see a similar reaction from U.S. stocks. Ditto once investors compare the U.S. to Europe (NYSEARCA:VGK).

The severity of the contraction in euro-zone growth remains to be seen. But with so many debt problems left unsolved, it’s bound to get uglier for the euro-zone economy.

Juxtapose that with a U.S. economy that’s no longer bogged down as much by lingering and high unemployment, and you’ve got reason to bet on the U.S.

And we expect a repeat of 2011 when U.S. financial assets outperformed every other major asset class in the world, except gold.

Sure, the 2.1 percent total return for the S&P 500 last year was a mere pittance compared with an average over the prior half-century of nearly 10 percent, compounded. But it was indeed welcomed. Euro-zone and emerging-markets shares lost 15.7 percent and 18.2 percent, respectively.

Furthermore, we believe U.S. Treasuries will continue to look better than any counterparts until a large degree of safe-haven buying recedes and growth/inflation expectations drive U.S. interest rates higher.

But there is a wild card — the U.S. dollar (NYSEARCA:UUP).

For the most part, the inverse correlation between the dollar and stocks, as well as the positive correlation between the dollar and Treasuries, could throw a wrench into the mix.

It’s clear the euro (NYSEARCA:FXE) is less favored than the dollar, and that trend is likely to continue. That is likely a boon for Treasuries, as capital flows to the U.S. But it’s not the best for stocks.

Stocks and the dollar can appreciate in value simultaneously. But it doesn’t happen often anymore since the dollar became the world’s funding currency of choice! Plus, a steadily rising dollar may sap some of the new life from the U.S. manufacturing sector and pressure the employment market further. And that’s why I think it makes sense to look deeper into the U.S. unemployment numbers than what the headline figures suggest.

Because …

The uptick in the employment trend DOES NOT rule out the possibility of a recession

There are several cases where employment trends ticked up just prior to the onset of a recession and in some cases sharply so. For instance:

In 1948 jobs ticked up 323,000 just before losing over 1 million the next year …

In June 1953 there was a jump of 437,000 jobs …

December 2000 picked up 292,000 and a whopping 647,000 in November of 2007 …

And in each case a recession ensued within a 2-month period.

At this point it might make sense to follow mainstream investors who mostly see improvement in the labor market based on headline figures. But be open to a disappointment considering the weak foundation on which this jobs recovery is thus far based.

If the nascent jobs recovery does encourage investors, then we can assume it will help drive U.S. growth expectations and support risk appetite.

After all, since the U.S. remains the largest national economy in the world, its status factors in heavily to global growth projections. The biggest question:

If risk appetite resurfaces can it exist in harmony with a stronger dollar? Or will risk appetite dominate and pressure the dollar (NYSEARCA:UDN) despite a relatively less bad U.S. economy?

As we suggested to our World Currency Trader subscribers this week, the euro is destined for further downside based on the continued debacle in the euro zone. It’s only saving grace would be a rising tide of risk appetite.

Best wishes,

Written By JR Crooks From Money And Markets

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss  along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson and  Bryan Rich. To avoid conflicts of interest, Weiss Research and its staff  do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance  returns cited are derived from our best estimates but must be considered  hypothetical in as much as we do not track the actual prices investors  pay or receive. Regular contributors and staff include Andrea Baumwald,  John Burke, Marci Campbell, Selene Ceballo, Amber Dakar, Maryellen  Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker,  Leslie Underwood and Michelle Zausnig.

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss  Research analysts offering the latest investing news and financial  insights for the stock market, including tips and advice on investing in  gold, energy and oil. Dr. Weiss is a leader in the fields of investing,  interest rates, financial safety and economic forecasting. To view  archives or subscribe, visit http://www.moneyandmarkets.com/.

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