S&P 500 AND NASDAQ EXCEED FOURTH QUARTER HIGHS -- WEAKNESS IN EURO MAY BE OVERSTATING DOLLAR WEAKNESS -- THAT'S STILL CAUSING FOREIGN SHARES TO LAG BEHIND THE US -- GERMAN, CHINESE, AND CANADIAN STOCKS STILL NEED TO ACHIEVE UPSIDE BREAKOUTS
S&P 500 AND NASDAQ CLEAR FOURTH QUARTER RESISTANCE... The U.S. stock market continues to lead the rest of the world higher. Charts 1 and 2 show the S&P 500 and Nasdaq Composite Indexes clearing their fourth quarter highs, which puts them in position to challenge the highs formed last summer and spring. The S&P is also clearing a eight-month down trendline (see circle). The fact that both indexes have been able to rise in the face of a rising dollar (falling Euro) is also impressive (see gray area in Figure 1). That raises a number of intermarket possibilities. One is that the market's "inverse" relationship to the dollar is changing. Another possibility is that the dollar rally is nearing an end (and the Euro is starting to bounce). Another possibility is that Euro weakness is making the dollar look stronger than it really is. One way to determine that is to look at the performance of other foreign currencies which are acting much better than the Euro.
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Chart 1
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Chart 2
OTHER CURRENCIES ARE MUCH STRONGER THAN THE EURO ... The Euro is the world's second biggest currency, next to the dollar. The Euro is also the most heavily-weighted currency in the Dollar Index (UUP) at 57%. The other five currencies in that basket carry a much smaller weighting. Three-quarters of the Dollar Index are European currencies (Euro, British Pound, Swiss Franc, and Swedish Krona). The Japanese yen and Canadian Dollars are less than a quarter of the Dollar Index. As a result, the recent weakness in the Euro is very much tied to Europe. When we look at non-European currencies, we get a much stronger picture (and weaker picture for the dollar). Chart 3 shows the Australian and Canadian Dollars bottoming during October and trading higher since then. That rebound in the two commodity-currencies occurred while the Euro (blue matter) fell to a new 52-week low. Chart 3 also shows the Japanese Yen rallying against the US currency since April. Chart 4 shows similar rebounds taking place in Brazilian Real and the Wisdom Tree Emerging Currency Fund (CEW). The CEW includes eleven emerging currencies which include the Chinese Yuan. The red matter below Chart 4 show the yuan trading at a 52-week high versus the dollar. The point of these charts is simply to suggest that Euro weakness is dominating the Dollar Index and making it look stonger than it really is against the world's other currencies.
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Chart 3
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Chart 4
CHINA AND GERMANY STILL NEED UPSIDE BREAKOUTS ... One of the side-effects of a stronger dollar that I discussed last week is that U.S. stocks usually do better than foreign stocks. That explains why the U.S. market has been doing much better than foreign shares of late. While that's good for U.S. stocks, it also carries a potential warning. Foreign stocks have not yet confirmed the upside breakouts in the US. Chart 5 compares Germany iShares (blue line) to the S&P 500 (green line). The good news is that the German stock market has bounced off chart support along its spring low (see boxes) and is starting to rally. While the S&P has exceeded its fourth quarter high, German iShares still a long way from doing so. That creates a possible "negative divergence" between the two. The blue matter below Chart 5 shows how much the German market has underperformed the U.S. over the last six months. Chart 6 shows a similar disparity between the S&P 500 and China iShares (FXI). The FXI, however, is now close to challenging its fourth quarter high. An upside breakout through that chart barrier would be positive for Chinese stocks and stocks everywhere else, including the US. The red matter below Chart 6 shows the FXI:SPX ratio trying to stabilize.
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Chart 5
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Chart 6
LET'S NOT FORGET CANADA... When looking abroad for potential trading opportunities, one country that often gets overlooked is Canada. Canada isn't included in EAFE iShares which are based on European, Australasia, and Far East stocks. Canada is the biggest trading partner for the U.S. and usually has a close correlation to U.S. stocks. Canada is also an exporter of natural resources and offers a way to participate in commodity price trends. The red line in Chart 7 shows Canada iShares (EWC) having bounced off chart support along its summer low (see circles). The EWC, however, remains below its November peak and its 200-day moving average. It needs to clear those two barriers to confirm the upside breakout in the U.S. The solid matter shows the close correlation between the EWC and the CRB Index. A bet on Canada is also a bet on the direction of commodity markets. A stronger Canadian Dollar would also help both.
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Chart 7
COMMODITIES ALSO NEED TO CATCH UP ... Another side-effect of the rising dollar is that it's have a depressing effect on commodity markets. As a result, the commodity rally isn't keeping pace with the U.S. stock market. It's too soon to determine if the stronger stock market performance is signalling a change in the relationship between the two markets, or is a short-term aberration (as is also the case with the relationship between stocks and the dollar). Stocks and commodities have been very closely correlated over the last decade and especially since mid-2008 (both moving in the opposite direction of the dollar). Chart 8 compares the S&P 500 to the CRB Index (solid matter) over the last year. Both peaked together during May and bottomed together during October. The CRB, however, has yet to clear its November peak. That's the result of a rising dollar. A weaker dollar might allow commodities to play catchup with stocks. That depends to a large extent on a stronger Euro. Personally, I'll feel better when commodity prices confirm the upside breakout in the S&P 500.
