NEW DOLLAR DOWNLEG MAY BE STARTING FROM BEARISH TRIANGLE -- THAT BENEFITS STOCKS AS WELL AS COMMODITIES -- THE FALLING DOLLAR ALSO GIVES AN ADDED BOOST TO FOREIGN SHARES

TRIANGLE FORMATION IS BEARISH FOR THE DOLLAR... My market message from two Thursdays ago (April 7) showed a bearish triangle forming on the monthly chart of the US Dollar Index. Chart 1 is an updated version of that chart and shows the two converging trendlines that have been forming since the 2008 bottom. The "symmetrical triangle" formed by those two lines is a "continuation" pattern and usually results in resumption of the prior trend which, in this case, has been down. The chart also shows the USD falling below the lower trendline which is a sign that the dollar downtrend may be resuming. The April 7 message ended with the observation that another dollar downleg would make commodities and foreign currencies good places to be. There is another side-effect of the falling dollar having to do with stocks, and foreign stocks in particular.

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Chart 1

FALLING DOLLAR ALSO FAVORS STOCKS ... Stocks have also benefited from a falling dollar. That's because stocks and commodities have been closely correlated over the last decade (as is usually the case during a deflationary decade). Chart 2 shows a generally inverse relationship between the Dow Jones World Stock Index (black line) and the U.S. Dollar Index (green line) over the last ten years. Notice that global stocks rallied from 2002 to 2007 as the Dollar Index tumbled. Stocks tumbled during 2008 as the USD bounced. Chart 3 gives a closer look at their inverse relationship since 2008. Note that each peak in the USD (early 2009 and mid-2010) coincided with upturns in global stocks. Assuming that inverse relationship holds, the recent downturn in the USD should be good for stocks (as well as commodities). While the falling dollar has been good for all stocks, it's especially good for foreign stocks. That's because a falling dollar usually favors foreign shares.

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Chart 2

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Chart 3

FALLING DOLLAR FAVORS FOREIGN STOCKS ... Our next two charts deal with the "relative" performance of foreign stocks versus the US. The black line in Chart 4 is a "relative strength ratio" of EAFE iShares (EFA) divided by the S&P 500. [EAFE stands for Europe Australasia and the Far East and is the most popular measure of foreign stocks]. The green line is the US Dollar Index. The chart shows an inverse relationship between the two lines. In other words, foreign stocks outperform the US (rising ratio) when the dollar drops. That happened from 2002 to 2008. The dollar bottom during 2008 has resulted in better US performance over the last three years. Chart 5, however, shows that each drop in the USD since 2008 has coincided with an upturn in the foreign/US ratio. In particular, notice that the mid-2010 upturn in foreign stock relative performance (rising ratio) coincided with the last peak in the USD (see arrows). That being the case, continued dollar weakness should give an added boost to foreign stocks. Interestingly, the sideways formation in the ratio line since 2008 in Chart 4 resembles a triangle pattern marked by two converging trendines (which coincides with a similar pattern in the Dollar Index). Except the ratio triangle is a bullish one while the dollar triangle is bearish. That suggests that another major downleg in the USD could push the foreign/US ratio back up toward its 2008 peak. EAFE iShares, however, may not be the best way to take advantage of that rising foreign trend.

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Chart 4

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Chart 5

VANGUARD EX-US ETF OFFERS BETTER FOREIGN STOCK DIVERSIFICATION ... My March 24 message carried the above headline and explained why the Vanguard ETF offers better foreign stock diversification than EAFE iShares. The article explained that EAFE iShares do not include stocks in North or South America (like Canada and Brazil) which have been among the world's strongest performers, and why that makes the Vanguard FTSE All-World ex-USA ETF (VEU) a better foreign stock diversifier. Chart 6 compares the performance of both foreign ETFS since the spring of 2009 when stocks bottomed. During those two years, the VEU (black line) has risen 64% versus an EFA (blue line) gain of 45%. A large part of the VEU's superior performance comes from a 100% gain in Canada and 120% in Latin America (the VEU has a 25% weighting in emerging markets which includes Latin America). The EFA excludes both of those global leaders. So if you're looking for an ETF that offers broader foreign stock diversification (to take advantage of the falling dollar), the Vanguard FTSE All world ex-USA ETF (VEU) does a better job that EAFE iShares (EFA).

Chart 6