RECENT DROP IN COMMODITIES HAS COINCIDED WITH DOLLAR RALLY -- LONG TERM DOLLAR CHART, HOWEVER, REMAINS BEARISH WHICH SHOULD BE POSITIVE FOR COMMODITY ASSETS -- EMERGING MARKETS TEST 200-DAY AVERAGES
COMMODITIES BOUNCE AS DOLLAR PULLS BACK ... I wrote on Tuesday that commodities (and stocks related to them) had fallen back to important support levels and were starting to stabilize. I also suggested that they appeared to present good value at current levels. As you know, the trend of commodity assets is largely determined by the trend of the US dollar. And, not surprisingly, the May commodity drop (price bars in Chart 1) has been accompanied by a jump in the US Dollar Index (green line). Needless to say, a major upturn in the dollar would be negative for commodities (and possibly for stocks), while renewed dollar weakness would be positive for those two asset classes. That being the case, the direction of the dollar has become a critical factor in the outlook for stocks and commodities. So let's take a technical look at the dollar.
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Chart 1
A LOT OF OVERHEAD DOLLAR RESISTANCE ... The weekly bars in Chart 2 show that the May rally in the PS DB Bullish Dollar Index (UUP) is still pretty small and remains well within the confines of its major downtrend. The flat red line drawn under the lows of the last three years represents a major resistance barrier (broken support becomes new resistance). The pink trendline extending back to last spring also comes into play around 22. In my view, that makes the 22 level a formidable resistance barrier to any further dollar rallies, and suggests that the recent bounce could prove short-lived. It that barrier caps the dollar rally, that should be good news for commodities and, most likely, for global stocks both of which are currently in downside corrections.
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Chart 2
DIRECTION OF DOLLAR WILL ALSO IMPACT FOREIGN STOCKS ... The relative attractiveness of foreign stocks is also largely determined by the direction of the US Dollar. Generally speaking, foreign shares do better than US shares when the dollar is weak. Chart 3 demonstrates that by comparing a ratio of EAFE iShares divided by the S&P 500 (black line) relative to the trend of the US Dollar Index (green line) over the last couple of years. The chart shows that the black ratio tends to rise (favoring foreign shares) when the green dollar line is weak. To the bottom right of the chart, however, you can see the foreign/US ratio dropping during May as the dollar has bounced (see arrows). That explains why foreign shares have fallen further than ours. That further suggests that the fate of foreign shares may also be determined by the direction of the greenback. That's especially true of emerging markets which are testing important long-term support levels.
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Chart 3
GLOBAL COMPARISONS... Chart 4 shows foreign stocks underperforming US shares since the start of the year. The black line shows the S&P 500 doing the best with a 2011 gain of +5%. The blue line shows EAFE iShares (which measure Europe Australasia and the Far East) coming in second with a 2011 gain of 3.30%. The weakest of the three is Emerging Market iShares (red line) which have lost -1.4%. Most of those foreign losses took place during May while the Dollar Index was rallying. It's normally not a good sign for global stocks when emerging markets are the weakest. That being the case, the fate of global stocks (including the US) may hinge on the ability of emerging markets to find chart support around current levels. That's especially important because a number of the larger ones are testing important support levels.
Chart 4
EMERGING MARKETS ARE TESTING 200-DAY LINES... To most technical analysts, the 200-day moving average is the proverbial "line in the sand". That's what separates bull markets from bear markets. And it just so happens that a number of big emerging markets are testing their 200-day lines. Chart 5 shows Emerging Market iShares (EEM) forming a "island reversal" on Tuesday's gap higher right at its 200-day line (red circle). Charts 6 shows the Market Vectors Russia ETF (RSX) regaining its 200-day line today. [Russia's market is closely tied to the trend of oil]. Chart 7 shows China iShares (FXI) doing the same. [China's direction also plays a major role in the direction of commodities]. Brazil iShares (EWZ) have dipped below their 200-day line. Chart 8, however, shows the EWZ bouncing off important chart support along its early 2011 lows. So here's the main message. The world's largest emerging markets have led the global pullback over the last month (as the dollar has rallied), but are testing very important support levels. In my view, the fate of the bull market in global stock markets depends on those tests being successful. So far, the action is encouraging. A weaker dollar (and stronger commodites) would be a big help.
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Chart 5
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Chart 6
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Chart 7
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Chart 8
100-DAY MOVING AVERAGE IS HOLDING ... My Tuesday message showed the S&P 500 testing its 100-day moving average (red arrow) and explained why that was such an important test. So far that line is holding. In order to declare that test successful, the SPX needs to clear a couple of shorter-term moving averages. A lot of attention is being focused on the 50-day average (blue line) which is just above the price action. While a close back above that line would be encouraging, I'm more concerned with the 20-day average (green line) which is a bit higher. The reason for that has to do with my blending of Bollinger bands. I explained in a recent message that daily bands which measure "short-term" trends use a 20-day average. "Intermediate" trends are better measured with a 20-week (or 100-day) average. For the current pullback to be contained, therefore, it's important that the longer-term 100-day line hold (red arrow). To signal that the short-term trend is turning back up, however, it's important that prices exceed the 20-day line (green arrow).
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Chart 9
S&P 500 ALSO TESTING MAJOR SUPPORT LINE... Chart 10 shows another reason why the S&P 500 is at a crucial chart point. It's testing the rising green trendline drawn under the August 2010 and the March 2011 reaction lows (see arrows). I recently expressed the view that the S&P had completed a five-wave advance from last July, and warned of a possible correction back to the March low. In order to prevent that from happening, it's important that the SPX find support along that trendline drawn under the two reaction lows. The S&P 500 would also benefit from renewed buying in emerging markets, stronger commodity markets, and a weaker dollar.
