DOLLAR WEAKNESS CONTRIBUTES TO CRB BREAKOUT -- SMALL CAPS AND TRANSPORTS APPEAR SET TO BREAK OUT NEXT WEEK -- S&P 500 BOUNCES IMPRESSIVELY OFF H&S NECKLINE -- MORE BULLISH WEEKLY SIGNS

CRB INDEX HITS EIGHT-MONTH HIGH... I wrote on Thursday that a falling US Dollar Index was bullish for commodities (and stocks tied to commodities). Chart 1 shows the USD hitting another eight-month low on Friday. Right on cue, the CRB Commodity Index broke out to a new eight-month high on Friday (Chart 2). The surge in commodities is part of the Fed's battle against deflation. By keeping rates unusually low and "devaluing" the U.S. currency, the Fed is creating a "reflation" trade. Rising commodities are not only good for commodity-related stocks, but stocks in general because they imply greater economic strength. The same is true of rising foreign currencies. Chart 2 shows that commodities started to rally in June when the dollar peaked. That's also when foreign stocks started to outperform the US.

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Chart 1

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Chart 2

EMERGING MARKET ISHARES HIT 2-YEAR HIGH... One of the side-effects of a falling dollar is that it favors foreign shares. Foreign stocks have been rising faster than the US since June when the U.S. Dollar started to fall (as I showed on Thursday). To emphasize just how strong foreign shares have been, Chart 4 shows Emerging Market iShares (EEM) hitting the highest level in two years. Chart 5 shows EAFE iShares (EFA) trading well over their summer highs and rising much faster than the S&P 500 (below both charts). Although foreign outperformance will continue as long as the dollar falls, there's some good news for US stocks. Since global shares usually trend in the same direction, stronger foreign shares are pulling US stocks along with them. That greatly increases the odds for higher US stocks between now and yearend.

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Chart 3

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Chart 4

SMALL CAPS AND TRANSPORTS NEAR BREAKOUTS... My Thursday message expressed the view that the Dow Transports and Russell 2000 Small Cap Index needed to break through their summer highs to confirm upside breakouts in the Dow Industrials and large cap indexes like the S&P 500. The good news is that the Dow Transports and RUT both gained more than 3% on Friday (making them the day's two strongest groups). Even better, Charts 5 and 6 show both indexes closing right at their August highs and apparently poised to break out to the upside next week. Meanwhile, the Dow Industrials (top of Chart 5) hit a new four-month high on Friday as well. An upside breakout by the Dow Transports would trigger a Dow Theory buy signal. An upside breakout by the RUT (Chart 6) would confirm previous upside breakouts by large and midcap stocks that took place last week.

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Chart 5

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Chart 6

S&P 500 BOUNCES OFF NECKLINE SUPPORT... Friday's strong rebound in the S&P 500 represented a successful of the "neckline" drawn along the June/August highs (as shown in Chart 7). [Technical theory holds that a pullback after an upside breakout from a "head and shoulders" bottom should bounce off the neckline which becomes a new support line]. Friday's volume also picked up which is encouraging. Hopefully, a bullish follow-through next week (which appears likely) will cause more enthusiastic buying and higher volume. Also encouraging is the resilience of the market during a seasonally weak period which usually lasts into the first couple of weeks of October. After that, seasonal trends turn much stronger. All in all, this past week's intermarket action (weaker dollar, stronger commodities, stronger foreign stocks) bodes well for US stocks between now and yearend.

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Chart 7

BULLISH WEEKLY SIGNALS... On Thursday, I showed weekly MACD lines turning bullish and mentioned that other weekly indicators had done the same. The line on top of Chart 8 shows the 14-week RSI moving above the 50 line for the first time in five months. That shows bullish momentum. The price bar shows the bullish breakout. The two moving average lines are the 13 and 34 week EMAs that I place a lot of importance on. They turned slightly bearish in July and August, but have now flipped back into positive territory. The daily EMAs (not shown), which measure the market's short-term trend, turned positive two weeks ago. Weekly signals occur later than dailies but carry a lot more weight. Right now, both dailies and weeklies are pointing to higher stock prices.

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Chart 8

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