WHY CANADA IS AN IMPORTANT PART OF THE GLOBAL INTERMARKET PICTURE -- CANADIAN STOCKS ARE STALLED AT 200-DAY AVERAGE -- SO IS THE CANADIAN DOLLAR AND CRB INDEX -- WHAT THEY DO FROM HERE WILL HELP DETERMINE DIRECTION OF U.S. STOCKS
CLOSELY CORRELATED WITH US MARKET ... Last Thursday's message argued for the inclusion of Canada in a foreign stock portfolio. I'm going to expand on Canada's unique role in the global intermarket picture in this message. In my view, Canada is unique for at least three reasons. First, it's very highly correlated to the U.S. stock market. That shouldn't be a surprise because Canada is the biggest trading partner with the U.S. It also means, however, that the two markets need to be charted together to ensure that they're sending the same messages. Another reason why Canada is important is because it's highly correlated to the Canadian Dollar. And the Canadian Dollar is closely tied to the trend of commodity markets. That's because Canada is one of the world's biggest exporters of natural resources. The Canadian markets, therefore, tell us a lot about the direction of global stocks, commodities, and currencies. Chart 1 compares the Toronto Stock Index (red line) to the S&P 500 (blue line) since 2000, and is simply intended to show the close correlation between the two markets. Over most of that time, the correlation coefficient (below chart) fluctuated between .75 and 1.00. One exception was during the first half of 2008 when Canadian stocks kept rising while the U.S. market plunged (see circle). That was due to the fact that commodity prices kept rallying into the middle of 2008 before peaking. Canadian stocks peaked with commodities.
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Chart 1
TORONTO INDEX IS STILL TESTING RESISTANCE ... Chart 2 compares the two markets over the last year. After rising and falling together throughout 2011, the two markets have diverged during January. While the S&P 500 has risen to the highest level in six months, the Toronto Stock Index (TSX) is stalled at its November high (flat line) and its 200-day moving average (red arrow). Until the TSX is able to break through those two resistance barriers, the continuation of the U.S. uptrend will remain in some doubt. Chart 3 shows Canada iShares (EWC) also testing overhead resistance at those same two resistance barriers.
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Chart 2
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Chart 3
CANADIAN DOLLAR ALSO TESTS RESISTANCE... Since the Canadian Dollar is closely correlated to Canadian stocks, it's no surprise to see similar chart patterns. Chart 4 shows the Canadian Dollar meeting resistance below its October peak and 200-day average (red arrow). Its October peak met with heavy resistance along its summer lows as well (flat line). What the "loonie" does from there could help determine what Canadian stocks do (as well as the U.S.). The Canadian currency is only one of two non-European currencies included in the Dollar Index (the other one being the yen). So what it does from here may also help determine the direction of the Dollar Index (below chart). Its direction may also give clues to commodity price direction.
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Chart 4
CANADIAN DOLLAR AND COMMODITIES ARE LINKED... The direction of the Canadian Dollar has some bearing on the direction of commodities. For one thing, the CDW usually trends in the opposite direction of the U.S. Dollar. For another, the CDW is a "commodity currency" which means it's influenced by commodity trends. Chart 5 shows the close correlation between the Canadian Dollar (red line) and CRB Index (brown line) over the last four years (see Correlation Coefficient below chart). So it's no surprise to see similar chart patterns between the two. With the CDW now up against resistance (see Chart 4), it's no surprise to see commodity prices in the same situation. Chart 6 shows the DB Commodities Tracking Fund (DBC) stalled at a downtrend line drawn over its summer highs. The DBC is also stalled below initial resistance at its November peak and 200-day average (red arrow). What all of these charts suggest is that Canadian stocks, the Canadian Dollar, and commodity prices are all up against resistance barriers (at the exact same time). What they do from here will help determine the direction of the U.S. stock market.
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Chart 5
