RISING DOLLAR MAY HOLD SILVER LINING FOR US STOCKS WHICH ARE HOLDING UP BETTER THAN FOREIGN STOCKS -- BUT IT'S HURTING COMMODITIES AND COMMODITY PRODUCERS -- IT MAY BE A GOOD TIME TO BUY SOME PROTECTION WITH AN INVERSE ETF
FOREIGN SHARES MUCH WEAKER THAN THE US... We've noted before that foreign stocks are acting much weaker than those in the U.S. The first two charts demonstrate that very clearly. Chart 1 shows the S&P 500 having fallen 7% from its mid-April high and trading between resistance at its (blue) 50-day average and support at its (red) 200-day line. That puts the S&P 500 in a downside correction within a major uptrend. Chart 2 paints a much more negative picture. It shows EAFE Index iShares (EFA) slipping back below their February low after having broken their 200-day average weeks ago. The EFA has lost 14% from its April high which is twice as much as the S&P 500 has fallen. [EAFE stands for Europe Australasia and the Far East]. Not surprisingly, the biggest foreign losses have been seen in Europe. Chart 3 shows EMU Index iShares (EZU) having fallen 17% from its January high (versus -9% for the EFA and +2% in the S&P 500). The EMU includes stocks in the European Monetary Union that have been hit the hardest by the recent plunge in the Euro. The flip side of the weaker Euro is the stronger U.S. Dollar which is helping U.S. stocks.
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Chart 1
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Chart 2
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Chart 3
A RISING DOLLAR FAVORS US SHARES ... When deciding between foreign shares and those in the states, the direction of the dollar is important. Chart 4 shows why. The black line is a ratio of the MSCI World index (ex USA) divided by the S&P 500. The green line is the U.S. Dollar Index. It's clear that the two lines usually trend in opposite directions. In the six years from the dollar peak in 2002 to its bottom in 2008, foreign shares rose faster than those in the U.S. From The peak in the dollar in early 2002 to its 2008 bottom, the ratio of foreign stocks to U.S. stocks rose. During those six years, foreign stocks outperformed U.S. stocks by 80%. Since the bottom in the dollar in 2008, foreign stocks have underperformed the U.S (by approximately 15%). One of the reasons for that trend is that money tends to flow to countries and regions with the strongest currencies (which reflect stronger economic conditions). In addition, American investors invested in foreign stocks lose money both from falling foreign stocks and the falling currency. While it's true that falling foreign currencies at the moment are causing more volatility (risk) in global stocks, the silver lining is that U.S. stocks are becoming a relatively safer place to be than foreign shares. Whether or not that trend continues depends a lot on the trend of the dollar.
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Chart 4
RISING DOLLAR HURTS MOST COMMODITIES ... It's also become clear that the rising dollar is taking a bearish toll on commodities and stocks tied to them (with the exception of gold). For one thing, a rising dollar is usually bearish for commodities. For another, the falling Euro and the resulting weakness in Europe is raising some doubt about the strength of the global economy. When that happens, economically-sensitive commodities (like copper and oil) come under pressure. Chart 5 shows the CRB Index breaking chart support at its February low. The rising dollar (green line) has a lot to do with that. [I recently expressed some skepticism about the rising Dollar Index because most of its strength was mainly against the Euro. More recently, however, most foreign currencies have started slipping against the dollar as well]. With commodities under pressure, commodity producers have also become underperformers.
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Chart 5
RISING DOLLAR HURTS COMMODITY PRODUCERS ... Since the dollar usually trends in the opposite direction of commodities, it stand to reason that dollar direction also impacts the relative performance of commodity producers. Chart 6 shows that to be true. The black line is a ratio of the Material SPDR (XLB) divided by the S&P 500. The green line is the Dollar Index. The two lines trend in opposite directions. In other words, a weaker dollar is good for commodities and commodity producers. A rising dollar is negative for both. Chart 6 shows commodity producers outperforming the S&P 500 from 2002 to 2008 as the dollar fell. They've done a bit worse than the market since the dollar bottomed in 2008 (see trendlines). Chart 7 shows the daily chart of the XLB since the start of the year. At the moment, it's trading around its 200-day moving, but remains above its February low. The XLB/SPX ratio (below chart) shows the relative weakness of the materials group. Needless to say, the direction of the XLB from here will tell us a lot more about the direction of the market, commodities, and the dollar (not to mention the global economy).
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Chart 6
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Chart 7
CORRECTION OR TRADING RANGE IN THE MAKING... There's little doubt that global stocks have peaked for the time being. So far, most of the damage has been seen in foreign shares, but U.S. stocks are selling off as well. One of the early warning signs that we point out was the upward spike in the VIX Index. I pointed out in early May that the VIX spikes when option traders feel the need for more protection against a possible market downturn. And it has turned down. The question is whether this is just a normal downside correction (after a five-wave advance) or something more serious. Another possibility is that the U.S. market is entering a broad trading range between its February low and its April high. [That's the normal scenario a year after a strong market rally coming out of a recession]. For that to happen, however, the February low must remain intact. Seasonal factors have also turned negative ("sell in May" seems to have worked this year). All of which suggests a more cautious market stance at this point. One possible piece of good news is that the four-year presidential cycle kicks in during the second half of the year which usually provides a good buying opportunity. That happens most often in the autumn period. For traders, a trading environment entails a dual strategy of buying dips and selling rallies. Investors might want to hold off on any new purchases for awhile until underlying supports have been successfully tested. It might not be a bad idea to raise a little cash in the meantime or buy some protection with an inverse ETF.
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Chart 8
BUYING AN INVERSE ETF FOR PROTECTION... A couple of weeks ago (May 6), I warned that the market appeared to be headed into a correction and suggested that it might be time to "buy some protection" with an inverse (or bear) ETF. One of those I showed is the ProShares Short S&P 500 (SH) which is shown in Chart 9. After spiking higher during the first week in May, it appears to be rising again (as the market weakens). Short-term traders can buy an inverse fund for profit. Longer-term investors can use it to protect a portion of one's portfolio during a market correction (without necessarily have to sell those holdings). Either way, this appears to be a good time to look at inverse ETFS for profit or protection. If and when the market turns back up again, inverse ETFs should be sold. Right now, it looks like the SH could reach its 200-day average before running into trouble. In the meantime, I'd place stoploss protection in the SH below last week's low at 48.87.
