New Home Sales Drop to a Record Low But Market Cries "Bull"

Despite a dismal number of new home sales in January, the stock market managed to stage a bounce after a two day decline (with 3 hours until closing bell, this could still change). The rise in stocks is largely attributed to Bernanke's congressional testimony in which he reiterated the need for zero rate policy for an "extended" period. In addition to the gains in stocks, we see the dollar and the yen hold on to most of their recent gains. So what does it all mean?

1. Equities - the market's muted reaction to the new home sales report is very bullish but it must be taken in context, namely, zero rate policy. For sure, cheap money supply has supported the recovery efforts. But it also had the undesirable affect of carry trades. We should not think of carry trade just in the sense of using dollars to buy other currencies. Instead, think of it in a broader sense where cheap US dollars are used to fund any number of riskier assets like stocks, bonds, real-estate, etc. Basically, with a zero  rate policy, one has no incentive to keep one's money in the form of (depreciating) cash. The stock market is showing clear signs of severe addiction to zero interest rates. We are sure to experience some sobering days in the future when the economy checks into rehab.
2. Strong dollar - How is it possible for the dollar and the stock market to rally at the same time? the answer, to a great extent, is the way we measure dollar strength, namely, the dollar index. The dollar index is a weighted index which tracks the dollar's strength against a basket of currencies, of which the euro alone accounts for more than 57% and the combination of euro+pound+yen accounts for more than 80%. This means that it's enough for the dollar to show strength against the euro and British pound in order to send the DXY higher. And there's good reason for the dollar's strength vs. the euro and the pound. While Bernanke is laying out his exit plans, the UK and the EU are knee deep in trouble with no end in sight to loose monetary policy.
3. Strong yen - We are used to seeing  a strong inverse-correlation between yen pairs and equities. When equities rise, yen eases (risk on) and when the stock market falls we normally see the yen rise (risk off). So it is important to note here that while stocks nearly regained their highs for the week, the yen stayed relatively strong, relenting only some of its recent gains. This price action is indicative of a shaky market sentiment.