MARCH TRADE DEFICIT NARROWS AS DOLLAR TESTS TOP OF 2005 TRADING RANGE -- WHY AN UPSIDE BREAKOUT WOULDN'T BE GOOD FOR STOCKS OR COMMODITIES
FOREIGN CURRENCIES FALL... The U.S. trade deficit for March was much narrower than expected. That's giving a boost to the U.S. dollar and is pushing foreign currencies lower. Charts 1 and 2 show the Canadian Dollar and the Euro in danger of falling below their 200-day moving averages. Even the Japanese yen, which has been stronger lately, is down today (Chart 3). The yen has been rising on rumors of a possible revaluation of the Chinese yuan. The U.S. Dollar is testing the upper end of its 2005 price range and its 200-day moving average. A rising dollar hasn't been good for stocks recently.
Chart 1
Chart 2
Chart 3
DOLLAR TESTING OVERHEAD RESISTANCE ... The chart of the U.S. Dollar index (plotted through Tuesday) shows it testing the top of its 2005 trading range and its 200-day moving average. Needless to say, that puts the greenback in a crucial testing zone. One of our readers asked if the Dollar chart had the look of a bullish ascending triangle. I have to admit that it does. An ascending triangle is identified by two converging trendlines with the upper line flat and the lower line rising. That does appear to be the case since the the start of 2005. But an upside breakout is still needed to confirm that bullish pattern. Those who think that would be bullish for stocks might want to compare Charts 4 and 5. They show that the S&P 500 and the Dollar have been trending in the opposite direction at least since last October.
Chart 4
Chart 5
THE DOLLAR AND THE S&P ARE TRENDING IN OPPOSITE DIRECTIONS ... The next chart compares the U.S. Dollar Index (green line) to the S&P 500 (red line) over the last two years. Their inverse correlation is pretty clear. The dollar fell throughout most of 2003 as the market rallied. The dollar bottom at the start of 2004 coincided with a market drop. The drop in the dollar starting in August of last year coincided with another upleg in stocks. Since the start of 2005, a rebound in the dollar has coincided with a weak stock market. This inverse correlation isn't necessarily the historical norm, nor will it last forever. But it is the case right now. I point this out at this juncture because a lot of eyes are watching the dollar as it tests its 2005 high. I'm sure any upside breakout in the dollar will invite TV analysts telling us why this is bullish for stocks. I'm not so sure.
Chart 6
ANOTHER LOOK AT THE DOLLAR ... There are several other chart reasons why the dollar is at a crucial chart juncture. Chart 7 shows that the USD is challenging a (red) down trendline starting exactly a year ago. The horizontal line shows that the USD is testing overhead resistance at the low formed at the start of 2004 (see circle). Needless to say what the dollar does here will have a ripple effect through other markets. Whatever the dollar does, gold will do the opposite as will most other commodities. Chart 8 shows gold testing its 200-day moving average and a two-year support line. The direction of the dollar may also have an impact on the stock market -- but in the opposite direction as well. [A wild card in dollar direction will be any decision by the Chinese to revalue the yuan. If and when they do that (and depending on how they do it), I suspect the dollar will drop and Asian currencies will gain].
Chart 7
Chart 8
COMMODITY RALLY TIED TO DOLLAR DROP ... The commodity bull market started at the same time that the dollar peaked at the start of 2002. They've been trending in opposite directions since. I don't happen to believe that there's enough evidence to say that the dollar is forming a major bottom. But it could easily move back up to its early 2004 peak (92.5) without upsetting its long-term decline. A dollar rally would probably pull the CRB Index back at least to its major up trendline. That wouldn't necessarily upset the bull market in commodities either. That does suggest, however, that commodities may be putting in an intermediate term top. That would be consistent with economic weakening and may also explain why basic material and gold stocks have been selling off so hard lately.
Chart 9
GRADUATION DAY TOMORROW... I'll be taking tomorrow (Thursday) off to attend my daughter's graduation from college. But I'll be back on Friday to try to make sense out of recent market moves. As far as I can see, little has changed over the last few days. The S&P 500 continues to bounce around between major support at its 200-day average and resistance at its 50-day line. That keeps the market in a short-term neutral range. I still believe that the market's major trend will have a downside bias over the next six months. But I don't recommend new action until the short-term picture clarifies.
Chart 10
