BULLISH DOLLAR BREAKOUT COINCIDES WITH EURO DOUBLE TOP -- THAT'S KEEPING DOWNWARD PRESSURE ON COMMODITIES -- RISING DOLLAR MAY BE HELPING SMALL CAPS -- CONSUMER DISCRETIONARY STOCKS ARE DOING BETTER -- HOMEBUILDERS LOOK SOLD OUT

EURO COMPLETES DOUBLE TOP ... One of the main intermarket factors behind the recent plunge in commodity markets has been new strength in the U.S. Dollar. That's because commodity prices and the U.S. Dollar trend in opposite directions. In fact, the bull market in commodities since 2002 has been based on a falling dollar and rising foreign currencies. Earlier in the week I showed the Power Shares US Dollar Fund (UUP) nearing a test of its June high and its 200-day moving average. Today's 1.5% surge has pushed the UUP (which is based on the Dollar Index) above both resistance points. That greatly increases the odds that the U.S. Dollar has bottomed. That's more a sign of foreign weakness than US strength. Chart 2 shows the Euro falling -1.8% today to complete a "double top" reversal pattern. The Euro has broken its 200-day average in the process. The plunge in the Euro (and most other foreign currencies) is due to the fact that foreign central bankers have kept short-term rates firm (or have been raising them) while the Fed was lowering rates. With foreign economies starting to tank, their central bankers will have to start lowering rates. That will narrow the gap between U.S. and foreign rates which is bullish for the Dollar.

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ALL FOREIGN CURRENCIES ARE DROPPING ... One of the myths of the past year was that foreign stock markets would be immune from the bear market in the states. We've shown several times that many foreign markets have actually fallen further than the US. Another myth was that foreign economies would hold up better than the US. As was the case in the US, falling stock markets warned of weakening foreign economies. The new realization by central bankers that things have gotten a lot worse than they anticipated means that foreign economies are in worse shape than the US. As a result, foreign bankers will have to start lowering interest rates (while the Fed stands pat or even raises rates). That's what the plunge in foreign currencies is reflecting. Chart 2 showed the recent plunge in the Euro. The next five charts show that downtrends now exist in the British Pound (Chart 3), Swiss Franc (Chart 4), the Japanese Yen (Chart 5), the Australian Dollar (Chart 6), and the Canadian Dollar (Chart 7). The Aussie and Canadian Dollars (which are known as "commodity currencies") have fallen especially hard of late due to falling commodity markets. Since foreign currency markets trend in the same direction of commodities (and opposite to the US Dollar), both are now falling together.

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FALLING DOLLAR MAY BOOST SMALL CAPS... One of the positive effects of a rising dollar is that it should reverse the global flow of funds into foreign markets that took place in recent years. The US should start attracting new funds. Another side effect is continuing weakness in commodity markets. While that's not good for commodity speculators, it's good for the Fed since it eases inflation pressures. That's helps parts of the U.S. market that are inflation-sensitive like consumer discretionary stocks (see next paragraph). Another potential side-effect of a rising dollar is investor preference for small cap stocks over large caps. A rising dollar usually favors the former. That may help explain the stronger performance by small cap stocks recently. Chart 8 shows the Russell 2000 Small Cap Index trading over its 200-day average today. It's the only stock index to accomplish that task. Its relative strength line (below chart) has been rising since March and surged over the last month. That coincides roughly with bottoming signs in the Dollar Index (bottom line). I suggested earlier in the week that small cap leadership is an ingredient in most market bottoms. A much more important test for the RUT (and the rest of the market) will be its ability to exceed its June high.

Chart 8

CONSUMER DISCRETIONARY SECTOR LOOKS STRONGER ... The next three charts show three views of the Consumer Discretionary SPDR. All three are showing improvement. The monthly bars in Chart 9 show the XLY to be in the most oversold condition since late 2002 (see RSI line). The Fibonacci retracement lines show that the XLY has retraced 62% of the 2003-2007 advance which is often a support arrea. Chart 10 shows a weekly price chart. Notice that the 9-week RSI (top of chart) and the weekly MACD lines (bottom of chart) are close to turning positive after failing to follow the recent price move into new low ground (which constitutes a positive divergence). The daily bars in Chart 11 show the XLY clearing its 50-day moving average. It would still have to clear its 200-day line and its May high to signal a major bottom. The rising relative strength line below the chart, however, shows stronger performance by this inflation-sensitive group since the start of the year. That's a sign of subtle improvement in this group and the market. The two main groups in this sector -- retailers and homebuilers -- ended the week on a strong note.

Chart 9

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Chart 11

CENTEX LOOKS PRETTY SOLD OUT ... I keep hearing that there's no sign of a bottom in the housing market. Of course, those dire statements are coming from the same people who didn't see any problem emerging a year ago. One of the best leading indicators of housing is the chart action of homebuilding stocks. So I thought I'd take a look at them. I'm using Centex because it's one of the bigger homebuilders and is representative of the rest of the group. The monthly bars in Chart 12 show the stock completing a bearish "double top" at the start of 2006. That's when I first starting to warn that the housing industry was in trouble. Even prior to that top, the 9-month RSI (solid line) and the MACD histogram (below chart) were giving negative divergences before turning negative at the start of 2006. There are reasons for encouragement on the chart. For one thing, Centex has reached potential chart support near its 2000 low. For another, the 9-month RSI is showing positive divergence from oversold territory. Thirdly, the MACD histogram (although still negative) is in the strongest position in two years. All of which leads me to suspect that housing stocks may have seen the worst. And, if they have, some stability in the housing market may not be far behind.

Chart 12

CRB INDEX BREAKS 200-DAY AVERAGE ... Today's dollar breakout pushed commodities into another big loss. The Reuters /Jefferies CRB Index lost 12 points today with virtually all commodities in the red. What was especially signficant is that the CRB closed below its 200-day moving average for the first time in a year (Chart 13). The next potential chart support is its March low near 380. The drop in commodities (which is coinciding with dollar strength) is giving a big boost to the stock market which ended the week on a strong note. The Nasdaq had an especially encouraging week. Chart 14 shows the Nasdaq Composite Index closing well above its 50-day moving average (blue line) and within striking distance of its 200-day average. Nasdaq leadership is a big help to the rest of the market. Chart 15 shows the Dow Diamonds closing above the 50-day line for the first time in more than two months. It did so on strong volume. That's a strong combination and turns the Dow's short-term trend higher.

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Chart 15