Dollar Rallies, Stocks Struggle. Is the Flight to Safety Back On?

Dow 10,000 lives, at least for another trading day. But before we shed a tear peeling the onion of the decidedly mixed data that was Friday's unemployment report, let's count our blessings U.S. equity markets are holding up as well as they are. The jobs numbers might be grabbing the headlines, but the real news is the euro has caught swine flu. That's why the dollar is rising -- and stocks are struggling.Lest we forget, major averages in Europe were hammered overnight amid increasing fear the so-called PIIGS of the continent -- Portugal, Italy, Ireland, Greece and Spain -- could welsh on their debts. That's put the flight to safety back on, and the inverse correlation between the dollar and equities holding true once again.

"In the overall scheme of things, considering the intense fiscal problems in Euroland, the prospect of sovereign debt defaults and the future of the regional monetary union, today's U.S. payroll report is really a secondary event," David Rosenberg, chief economist and strategist at Canada's Gluskin Sheff, told clients Friday.

And so, helped mightily by a crashing euro, the good old buck is back with a vengeance. Indeed, the U.S. Dollar Index, which measures the greenback against a trade-weighted basket of six major currencies, has gained nearly 5% since mid-January -- a huge move in currency terms -- and the relatively risky asset class of equities is paying the price. The dollar found its footing on January 14 and since then the Dow Jones Industrial Average ($INDU) has given up more than 7% and the broader S&P 500 ($INX) has sloughed off more than 8%.

"The U.S. dollar has broken out on the upside, and while this is more a reflection of the problems overseas than anything overly encouraging State-side, the charts again are telling a story of a flight-to-safety not unlike what we experienced in late 2008 and early 2009," Rosenberg says.

John Stoltzfus, chief market strategist at Ticonderoga Securities, says the specter of sovereign default has brought a level of uncertainty to the markets more unnerving than the implosion of financial firms that set off the first round of the flight to safety in 2008, after Lehman's demise.

"What the market has found most disconcerting in the latest round of 'shoes a droppin' is that the shoes are not the perfect cap toes of the banking sector to which we've all grown accustomed, but the parade boots of the public/sovereign sector -- the sector that ultimately is the sector of last resort," Stoltzfus wrote Friday.

It seems that as long as macroeconomic concerns trump domestic data (such as a surprisingly strong quarterly earnings season), the near-term trend for stocks is not encouraging. Lehman Brothers blowing up is one thing; an entire European nation going bust is quite another.