Eight years ago I wrote my first commentary on the structural decline of the US dollar and that stream has continued, though as the years pass these articles attract noticeably less contempt.

Nowadays assessing the dollar’s short-term prospects is a far more fraught proposition; almost everyone you talk to these days has a theory about the dollar;s woes, many of which are invalidated when something unexpected happens. Here’s my take. Investors should expect a strong rally in the dollar and, accordingly, a correction in gold prices and the euro. As a weaker dollar has traditionally been a positive for Asian equities, so those markets could also suffer a slight correction.
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That being said, I expect the markets to perform well in December and enter 2010 on a positive note. The US economy has the potential to surprise on the upside, as sentiment remains negative.

As I noted in The End of America as We Know It, the US economy and labor market are undergoing profound structural changes.

But before you panic, remember that this will be a multiyear process. And the US stock market is becoming increasingly disengaged from the economy; the big US companies operate in multi-country platforms, and the home country featuring less prominently in the big picture.

Investors have been slow to recognize that the heavily indebted economy is in transition and slow to warm to a huge market rally. For what it’s worth, this is the right “mistake” to make, as investing becomes a secondary issue when everything else is collapsing.

Investors usually focus on the unemployment numbers to ascertain whether the economy is in recovery, reasoning that economic conditions will improve if employment is on the rise. This will be the crucial test for the sustainability of the economic recovery that’s now underway.  If the labor market fails to improve, then the economic recovery will be much more anemic than analysts currently expect.

For now central banks will continue their accommodative monetary policies, as they know that the recovery is fragile and sentiment is not at its best. It would be be premature to shift your whole portfolio to defensive sectors, as these should underperform if markets close the year higher.

With the markets running on liquidity and the global economy expected to perform better next year, global markets are in a sweet spot.

Finally, I would like to recommend reading (or rereading) The Case against Bernanke, an article by Stephen Roach that appeared in the August 25 issue of the Financial Times.