A STRONGER DOLLAR IS BETTER FOR US STOCKS -- FOREIGN STOCKS, HOWEVER, STILL NEED TO CONFIRM UPTURN IN US MARKET -- BUT CAN US STOCKS SHAKE THEIR INVERSE LINK TO THE GREENBACK
RISING DOLLAR IS BETTER FOR US STOCKS... There's good and bad news in the recent rally in the U.S. dollar. First the good news. The past year's dollar rebound appears to be part of a major bottoming formation that started during 2008. Starting with that that year, the USD has traded sideways in an attempt to bottom. That bottom won't be complete until the USD is able to exceed its 2010 peak which is still a long ways off. If the dollar is bottoming, however, that may have important implications for how the U.S. market does relative to foreign stocks. A stronger dollar also carries some potential dangers for both. The blue line in Chart 1 plots a ratio of foreign stocks (EAFE ishares) divided by U.S. stocks (the S&P 500). The rising blue line between 2002 and 2008 shows foreign stocks outpacing U.S. stocks. That was the direct result of the falling dollar. Since the dollar bottomed in 2008, foreign shares have been doing worse than the U.S. The green arrows show three upturns in the dollar over the last three years. Each of those upturns coincided with downturns in the EAFE/SPX ratio (blue arrows). The rising dollar during 2011 explains why foreign shares fell much further than U.S. stocks. That should remain the case as long as the dollar stays strong. The problem lies in the fact that the U.S. stock market needs stronger foreign shares in order to continue its recent rebound.
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Chart 1
FOREIGN STOCKS NEEDS TO SHOW MORE STRENGTH... Charts 2 shows EAFE iShares (EFA) finding chart support along its spring 2010 lows. That's good. Chart 3 shows Emerging Market iShares (EEM) doing the same. That's also good. The problem is that neither foreign index has even come close to challenging its 200-day moving average (red lines). Therein lies the danger in the "negative divergence" between U.S. and foreign stocks. Although the U.S. stock market is benefiting from a stronger dollar, it needs upside confirmation from foreign stock markets. So far, that upside confirmation has been missing. The bottom line is that foreign stocks have to start rising back above their 200-day averages in order to confirm recent upside breakouts in the U.S. market.
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Chart 2
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Chart 3
CAN DOLLAR SHAKE INVERSE LINK TO THE DOLLAR?... Another question relating to the rally in the dollar is whether or not the U.S. stock market can shake its inverse link to the dollar. Chart 4 shows that important turns in the Dollar Index since 2008 have generally been accompanied by turns in the S&P 500 in the opposite direction (with the exception of early 2010). Chart 5, however, shows the Dollar and S&P 500 moving higher together over the last month (see box). The question is whether that change in their relationship is a short-term aberration or a major change in the decade-long inverse relationship. Another way to put it is whether or not the U.S. stock market can continue rallying in the face of a falling Euro and relatively weak European markets.
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Chart 4
