PLUNGING DOLLAR RATTLES STOCKS -- PRECIOUS METALS GAIN -- SO DOES THE FALLING DOLLAR FUND -- S&P 500 SIGNALS SHORT-TERM TOP -- THE NASDAQ MAY RETEST ITS SPRING HIGH
DOLLAR INDEX FALLS TO SPRING LOW... Last Wednesday I wrote about the likelihood of the U.S. Dollar Index heading for a test of its spring low. [I also wrote about the long-term negative implications for the dollar if it were to break that low]. The daily bars in Chart 1 show the plunge in the dollar through Friday. [It fell again today especially against the Euro which is trading at the highest level in twenty months against the dollar]. Although a drop in the dollar's value doesn't always translate into weaker stock prices, it seems to be doing so this time. Part of the reason is the short-term overbought nature of the stock market which was probably in need of some correcting or consolidating. Another is the fact that the dollar's fall is based partly on the belief that the U.S. economy is weakening. As a result, the Fed is expected to start lowering rates while the rest of the world (especially Europe) is raising rates. U.S. bond yields are also falling faster than comparable foreign rates, which is also dollar bearish. [Although U.S. bond yields are still higher than foreign bonds, the spread between them is narrowing]. The main fear is that a further breakdown in the U.S. currency might cause foreign investors to start selling U.S. assets. Judging from today's market reactions, that fear is hurting stocks more than bonds.
Chart 1
BOND/STOCK RATIO BOUNCES OFF SUPPORT ... Bonds did better than stocks today. Part of the reason is that bonds do better than stocks in a slowing economy. Another reason may be more technical. Chart 2 is a simple ratio of the 7-10 Year T-bond ETF (IEF) divided by the S&P 500. The ratio bottomed in May (when money rotated out of a correcting stock market into bonds) and rallied until mid-year. The ratio started falling during August when the stock market rally started and money moved back into stocks. The chart shows the bond/stock ratio starting to bounce off chart support along its May low. To me, that suggests that bonds are undervalued relative to stocks at the moment. As bond prices rise, bond yields fall which hurts the dollar. The falling dollar is causing profit-taking in stocks.
Chart 2
FALLING DOLLAR PROFUND RISES... The most direct beneficiary of the falling greenback is the Falling US Dollar ProFund which I wrote about last Wednesday. As its name implies, the FDPIX is designed to rise when the dollar falls. Chart 3 shows the inverse fund (plotted through Friday) testing its spring high. If the dollar continues to fall, this fund is an excellent way to benefit accordingly. Right behind that comes precious metal assets.
Chart 3
SILVER EXCEEDS SEPTEMBER PEAK... Precious metal assets usually rise when the dollar falls. And that's what they've been doing. Chart 4 shows the Silver iShares (SLV) breaking through their September peak. Chart 5 shows the Gold Trust Shares (GLD) trading at a three-month high.
Chart 4
Chart 5
XAU INDEX IS TESTING DOWN TRENDLINE ... Gold stocks are also showing gains. Chart 6 shows the Gold & Silver (XAU) Index testing its six-month down trendline. It's one of the few areas of the market in the green today. The relative strength ratio below Chart 6 shows that the XAU has been doing better than the S&P for the last month. That's what usually happens when the dollar starts falling. Chart 7 is a point & figure version of the XAU. The initial buy signal given during October is still intact.
Chart 6
Chart 7
A TEST OF 50-DAY AVERAGE APPEARS LIKELY ... The daily bars in Chart 8 show a deteriorating short-term condition in the S&P 500. Last Tuesday, I suggested that the daily MACD lines for the S&P 500 could be forming a short-term "negative divergence". That occurs when prices hit a new high, but the MACD lines don't (see arrow). That's only a warning of a possible short-term top. A more convincing negative signal is given when the MACD lines cross downward -- as they're doing today. The first level of support is the early November low (at 1361) and/or the 50-day moving average (at 1365). For today's selling to remain just a short-term pullback, it's important that those support levels hold.
Chart 8
SMALL CAPS BACK OFF FROM MAY PEAK ... Another technical reason that might explain today's profit-taking has to do with small cap stocks. The market rally since August has been led by large-cap stocks. As a result, small caps have lagged behind. The relative strength line at the top of Chart 9 shows how much small caps have lagged behind large caps since May. Of more immediate concern is the fact that the S&P 600 Small Cap Index (SML) had risen to within a couple of points of its May peak near 405. That May peak is a logical spot to expect some small cap profit-taking. Ironically, small caps are the weakest part of the market today and are leading the rest of the market lower.
Chart 9
NASDAQ MAY RETEST ITS SPRING HIGH ... The short-term picture for the Nasdaq market also looks toppy. Chart 10 shows today's 2.11% drop in the Nasdaq Composite (on rising volume). The lines on top of the chart look ominous. The green (+DI) line is still trading over the red (-DI) line. But they've started to converge. In addition, the black ADX line is trading over the green line and appears to be peaking. That combination is usually a sign of a short-term top. The real test for the Nasdaq will be its ability to stay above its May peak near 2378 and/or its 50-day moving average (currently at 2340 and rising). That will also be a big test for the rest of the market. Those looking to take some "short-term" profits now have reason to do so. Those looking to commit some "longer term" funds to the market might want to hold off until some underlying support levels have been tested.
Chart 10
