DISAPPOINTING JOB REPORT HURTS DOLLAR, BUT HELPS STOCKS -- CYCLICALS, SMALL CAPS, AND NASDAQ HOLD 50-DAY LINES -- ODDS FAVOR FEBRUARY TRADING RANGE
THE KEY IS INTEREST RATES... One news source today attribued the stock market rebound to the jobs picture "brightening". The drop in the dollar, however, was explained by "disappointing" job figures. While those reports seem to be in conflict, they're not too far from being right. The fact that job creation was smaller than expected does explain the bullish reaction in stocks and the bearish reaction in the dollar. It has to do with interest rates. Since the Fed hinted last week that it might raise rates sooner than planned, the feeling has been that the Fed was waiting for strong jobs figures as a pre-requisite to begin tightening. In that scenario, good employment figures would increase the odds for higher rates. Higher rates would be good for the dollar, but could hurt stocks. Weak job data diminishes the chance for higher rates. That's why bond prices jumped after Friday's report. That pushed rates lower which hurt the dollar. Lower rates helped the stock market rebound from a short-term oversold condition. Chart 1 shows the 10-year T-note yield for the last year. Chart 2 plots the trend of the Dollar Index. Although the dollar has been much weaker than T-note prices, there is a correlation. Last summer's jump in yields produced a bounce in the dollar. The dollar started dropping again at the start of September when yields peaked. The recent rebound in yields over 4% has also coincided with a dollar bounce. Today, the dollar and yields dropped. So in this unusual intermarket world, a weaker dollar is actually good for stocks if it also means lower rates. At the same time, the dollar may stay weak until interest rates start to rise. That would be bad for stocks. With attention to interest rates moving to the front-burner, bad news may start being good for stocks. Good news may start being bad.
Chart 1
Chart 2
G7 FOCUS ON THE DOLLAR... The Group of Seven Finance Ministers are meeting this weekend to discuss the falling dollar. If pressure keeps mounting, one of two things will probably happen. The Fed will come under increased pressure to raise U.S. rates to stabilize the greenback. Or, the Europeans may start thinking more seriously about lowering rates. What they say (or don't say) over the weekend could determine the immediate trend of the dollar. The markets' vote on Friday was for a continued descent. That explains why gold prices jumped $5.00 at week's end to stay safely over the $400 level and gold shares gained 4%. While the short-term impact on our markets may be negligible, there are some long-term dangers of a falling dollar and low U.S. interest rates. Asian central bankers hold huge dollar reserves which have been invested in U.S. Treasuries. A number of them this past week hinted that they may start looking elsewhere for better returns. That means moving money out of dollar-based bonds into higher-yielding currency debt. If that were to happen, that could weaken the dollar even further, but boost interest rates. We're still a ways from that happening, but it's something to keep in mind down the road.
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CYCLICALS AND SMALL CAPS BOUNCE OFF 50-DAY LINE... Two key groups that have fallen the hardest over the past two weeks have been cyclical and small cap stocks. I've talked about some rotation out of these former leaders over the last month or so. On Friday, however, both indexes bounced off their first line of defense at their 50-day moving averages. The 14-day stochastic lines have also turned up from oversold territory under 20. Both charts show this to be the most oversold condition for that oscillator since last November. Unfortunately, the daily MACD lines are still negative. The good news it that those two key indexes survived their first important test of support.
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NASDAQ HOLDS INITIAL SUPPORT... The Nasdaq market also survived a couple of important tests of support. Earlier in the week I talked about the Nasdaq/S&P 500 ratio testing its December low. Chart 6 shows that the December low has held so far. Chart 7 shows the Nasdaq Composite bouncing off its (blue) 50-day moving average on Friday and staying above its December high near 2000. Daily stochastic lines are under 20 and turning up from oversold territory. Although volume was relatively light, breadth figures were impressive. The chart also shows the Nasdaq bouncing off its lower Bollinger Band (green line). That makes the (dashed) 20-day average the first level of overhead resistance. The black line in the bottom box is the Average Directional (ADX) line. It measures the strength of an existing trend. The fact that it has turned down from over 40 suggests that the Nasdaq may be entering a more choppy period than was the case from the middle of December. That may support the idea that the Nasdaq (and the rest of the market) will continue to consolidate in a sideways trading range for the balance of February. That means that we may have seen both the highs and the lows for the time being.
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INTEL HOLDS SUPPORT AT 30... Earlier in the week Intel was shown testing important support at its November low near 30. It was pointed out at the time that Intel's ability to hold above that support level could have some bearing in the Semiconductor group and the Nasdaq market. Chart 8 shows that Intel has so far stayed over that key support level. That would also suggest that the tech sector may have seen its worst for now and may attempt a rebound next week. That may also be reflected in Friday's 4% jump in the SOX Index.
Chart 8
ROLE REVERSALS ON FRIDAY... For the week, the technology sector has been a market laggard. At the same time, defensive consumer staples were the top sector over the entire five days. Friday's jump in the Nasdaq, however, caused a reversal of those roles. Techs were the top Friday sector, while consumer staples were the weakest. We're not sure which of the two trends to believe, but we usually give more credence to the longer-term one. We'll be watching closely next week to see what kind of follow-throughs we get from Friday's stronger market action. My best guess at this point is that the market has seen its highs for awhile and that we've seen only the beginning of more defensive market rotations. Having said that, we may see some retracement of recent moves over the next week or so resulting from short-term market extremes having been reached. The fact that weekly indicators still look toppy, however, should put a cap on market gains. It's important that this week's lows hold. Even if they do, I expect that more choppy action lies ahead. Remember that the historical pattern for February is correction "or consolidation".
