Recent economic indicators have shown further weakness in the state of the economy, yet investors remain optimistic, focusing on recovery. While there has been some concern about inflation heating up, perhaps investors need to be worried about another possibility—stagflation.

Jobless claims moved up unexpectedly to 576,000 in the week ended August 15, 2009, up 16,000 from analysts’ forecasts. Extreme weakness has also been evident in Asian markets; China’s Shanghai Index is down 20 percent from its highs. Standard & Poor’s just issued a report showing corporate defaults worldwide rose in 2009, and have already surpassed the number for all of 2008. A total of 201 issuers have defaulted through August 12, affecting $453.1 billion of debt.

The NASDAQ, S&P 500, and Dow Jones Industrial Average have managed to shrug off negative fundamentals in the last few sessions, forging higher to climb the wall of worry. I’m left asking myself how much longer this can continue with few signs of growth in the economy–not to mention–no clear indication as to the end of the recession. Don’t get me wrong, I enjoy a good bull market just as much as the next person, but it looks increasingly evident to me that there may be outside factors involved.

When I mention “outside” factors, I’m speaking in regard to the Federal Reserve, President’s Working Group on Financial Markets (a.k.a. the “plunge protection team, or PPT), and possibly larger financial institutions such as Goldman Sachs and JP Morgan.

In order to see a rally such as we’ve had of late, we need to take into account the action in the U.S. dollar. On March 4, 2009, the ICE U.S. Dollar Index futures peaked at 89.71, and since then, it has seen a steady decline to a current level of approximately 78.50. One day after that dollar peak, we saw the S&P 500 bottom out at 665.75, and it hasn’t looked back since.

You could also look at the price of oil and see the same correlation. The weak dollar has given stocks and commodities a boost. However, looking forward, a significantly weaker dollar will haunt U.S. consumers and will not help spur growth in our economy; it will help spur growth in the costs of goods and services, which could lead us into stagflation.

Stagflation: An economic situation in which inflation and economic stagnation occur simultaneously and remain unchecked for a period of time.

While it all seems as if “happy days” are on the horizon, remember that it’s going to take a heck of a lot more to spur on economic growth than the “fools gold” stock market rally we’ve seen as of the last few months. Further cost-cutting measures by the major U.S. corporations may continue to help put money back into investor’s pockets in the form of positive earnings, but when will these corporations be able to take the next step and start putting the approximately 9.5 million unemployed Americans back to work? That’s the key.

Trade Strategy

In terms of a trading strategy, if you are short, my recommendation is to stay short S&P 500 and DJIA futures from approximately 996.00, and 9,250, respectively. If you are not in the market as of yet, consider selling the September S&P futures at approximately 1,004.00 with a stop above 1,018.00. Look for a test on a move down to 983, and adjust your stop-loss to 996. My profit objective for this trade is 962. Also, consider selling S&P 950 puts as a hedge for approximately 10.50 points. If you have any further questions about the markets or are interested in hearing about other strategies to suit your particular situation, please don’t hesitate to contact me.

John Caruso is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted division. He can be reached at 800-445-0567 or via email at

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