FALLING DOLLAR GIVES BOOST TO EUROPEAN SHARES -- EUROPEAN STOCK INDEXES BREAK THROUGH RESISTANCE BARRIERS -- GERMANY ISHARES ARE CHALLENGING 2011 HIGH -- BOUNCING YEN HURTS JAPANESE STOCKS -- EUROPE LOOKS LIKE BEST BET FOR FOREIGN STOCK DIVERSIFICATION
DOLLAR THREATENS SUPPORT ZONE... The U.S. Dollar has been falling since the start of July, when it failed a test of its May peak. It's now nearing a test of an important support level. Chart 1 shows the PowerShares US Dollar Index (UUP) threateningn its July intra-day low. Needless to say, a decisive close below that previous low would be a negative sign for the greenback. A weaker dollar has intermarket implications. For one thing, a weaker dollar would give a much-needed to boost to oversold commodity markets, especially precious metals. A more important intermarket effect has to do with the relative strength between U.S. and foreign stocks. I'm thinking of Europe in particular. Charts 2 through 4 show upturns in the British Pound, Euro, and Swiss Franc over the last month. The pound is close to exceeding its 200-day average (Chart 2). The Euro and Swiss Franc have cleared their 200-day lines and are nearing tests of their June highs. At the same time, global money is starting to flow into European stocks.
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Chart 1
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Chart 2
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Chart 3
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Chart 4
FALLING DOLLAR BOOSTS EUROPEAN STOCKS ... My July 30 message showed that a strong dollar since 2008 has helped U.S. stocks outperform foreign stocks. Needless to say, a dollar breakdown would reverse that trend. Recent dollar weakness is already giving a relative boost to European shares. The green line on top of Chart 5 shows the trend of the Dollar Index (UUP) since the start of 2012. The blue line is a ratio of Europe 350 iShares (IEV) divided by the S&P 500. Their inverse correlation seems pretty clear. A drop in the dollar in mid 2012 coincided with an upturn in the Europe/U.S. ratio (first vertical line). A dollar upturn near the start of 2013 pushed the Europe/U.S. ratio lower (second vertical line). Since the start of July, a weakening dollar has given a boost to European stocks relative to the U.S. (a rising ratio).
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Chart 5
EUROPE ISHARES REACH FIVE-YEAR HIGH... The weekly bars in Chart 6 show the Europe 350 iShares (IEV) having broken through their 2011 highs to reach the highest level since 2008 (five years ago). That's a good sign for Europe. The dashed line shows the IEV/SPX ratio showing early signs of improvement. [The two biggest weightings in the IEV are the United Kingdom (33%) and Switzerland (16%). France and Germany comprise 14% and 13% of the IEV respectively]. Chart 6 shows the EMU Index iShares (EZU) trading at the highest level in two years. It has yet to clear its 2011 peak. The EZU includes stocks in the eurozone (which exclude Britain and Switzerland). Its two biggest holdings (and top performances) are France and Germany. The EZU, however, is being held back by Italy and Spain. Its relative strength ratio is showing improvement relative to the U.S.
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Chart 6
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Chart 7
GERMANY ISHARES TEST 2011 HIGH... The German economy is the biggest and strongest in Europe. Stronger economic news in Germany suggests that country may be leading Europe out of its longest recession since World War 11. I look to market action for clues to the direction of a stock market and an economy. That's because stocks are the best leading indicators of a country's economy. The weekly bars in Chart 8 show Germany iShares (EWG) in the process of challenging their 2011 highs. A decisive close above that chart barrier would represent a bullish breakout for German stocks, and would be a positive sign for the rest of Europe. Chart 9 shows the German DAX Composite Index in the process of challenging its 2000 and 2007 highs. A decisive upside breakout would also be a bullish development for Germany. [Britain's FTSE Index is also challenging its 2000 and 2007 highs]. Investors who believe the U.S. market has gotten over-extended might want to consider some allocation to Europe. That will be more true if the U.S. Dollar continues to weaken. [The reason the DAX chart looks stronger than the EWG has to do with weaker Euro since 2008. The DAX is quoted in Euros and the EWG in dollars. A weaker Euro (stronger dollar) since 2008, has caused the iShares to underperform the DAX. A stronger Euro would give a bigger boost to the iShares].
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Chart 8
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Chart 9
RISING YEN PRESSURE JAPANESE STOCKS... While a firming Euro is giving a boost to European stocks, the bouncing yen is having the opposite effect on Japanese shares. That's because Japan's stocks and the yen trend in opposite directions. Chart 10 shows the Japanese yen trading at a two-month high and forming a pattern of "rising bottoms" between May and July. The bouncing yen has caused selling in Japan iShares (EWJ) (orange bars). As I suggested in a recent message, Japanese stocks need a weaker yen to resume their uptrend. So far, there's no sign of that happening. With Japan under pressure, and emerging market shares showing no signs of bottoming, Europe appears to be the best foreign bet at the moment.
