HOMEBUILDERS MAY BE GETTING A LIFT FROM STRONGER LUMBER PRICE AND FALLING BOND YIELDS -- A DOLLAR BREAKDOWN WOULD FAVOR FOREIGN MARKETS RELATIVE TO THE U.S. -- EURO IS TESTING MAJOR TRENDLINE RESISTANCE WHILE THE POUND HITS FIVE-YEAR HIGH
BOUNCE IN LUMBER MAY HELP HOMEBUILDERS... My April 23 message showed the Dow Jones U.S. Home Construction iShares (ITB) testing support at its 200-day moving average. The homebuilding ETF bounced off that support line this week (see circle). A weak housing sector has been a drag on the economy during 2014. Any sign of strength there would be a welcome sign. So would be any sign of strength in the price of lumber. That earlier message suggested that a falling lumber price during 2014 was a sign of lower housing demand, and a stronger lumber market might be a sign that the housing sector was starting to recover. There may some encouraging signs there as well. Chart 2 shows the price of lumber climbing this week to the highest level in a month (see box). That bounce is taking place from a potential support zone between the 50% and 62% Fibonacci retracement lines. In addition, the 14-day RSI line (top of chart) and daily MACD lines (below chart) have risen above falling trendines (see circles). Falling bond yields may also help.
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Chart 1
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Chart 2
FALLING BOND YIELDS SHOULD HELP HOUSING ... The direction of bond yields has a big influence on the strength of the housing market. That's because bond yields determine the cost of a home mortgage. Chart 3 compares the direction of the 10-Year Treasury Note Yield (green line) to the DJ Home Construction iShares (brown line) over the last year. The upward spike in bond yields last spring (after the Fed starting talking about bond tapering) caused a sharp decline in homebuilding stocks (see arrows). A pullback in bond yields last September and again in January of this year helped boost homebuilding shares. Bond yields stabilized in February which may have contributed to another pullback in homebuilders. Chart 4 shows the 10-Year yield this week falling to the lowest level in three months and nearing a test of its February low. [The 30-Year T-bond yield has already fallen to the lowest level in ten months]. A drop below the February low would lower mortgage rates even further and might help revive interest in homebuilding stocks.
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Chart 3
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Chart 4
U.S. DOLLAR IS TESTING IMPORTANT SUPPORT LINE... Another potential side effect of falling U.S. bond yields is a weaker dollar. The dollar has been weakening since the start of the year, and is now in the process of testing some important chart support. The weekly bars in Chart 5 show the U.S. Dollar Index ($USD) testing a support line drawn under 2012-2013 lows. A decisive close below that trendline would represent a technical breakdown in the greenback. There would be at least two possible side effects if that were to happen. One would be a boost in commodity prices (like gold) which generally rise when the dollar falls. Another potential side effect of a weaker dollar is that it favors foreign stocks over U.S. stocks. That's even more true of foreign markets that produce commodities -- like Brazil and Canada. We may already be seeing that happen.
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Chart 5
FALLING DOLLAR BOOSTS FOREIGN STOCK PERFORMANCE... Chart 6 compares the Dollar Index to a "ratio" of EAFE iShares divided by the S&P 500 (blue line). The ratio shows how foreign developed markets in Europe Australasia and the Far East are doing "relative" to the U.S. market. Chart 6 shows that the two lines generally trend in opposite directions. Upturns in the U.S. dollar in the summer of 2011 and the start of 2013 coincided with weaker foreign performance (falling ratio). Dollar peaks in the summers of 2012 and 2013 strengthened foreign performance (rising ratio). The EAFE/SPX ratio has jumped over the last month as the dollar has weakened (see circles). Given that historic relationship, any serious dollar breakdown from here would give a boost to foreign currencies and foreign stock performance along with them.
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Chart 6
EURO TESTS RESISTANCE LINE ... The weekly bars in Chart 7 show the Euro testing a major resistance line drawn over its 2008/2011 highs. An upward break of that trendline would be bullish for the Euro and bearish for the dollar. [The Euro accounts for 57% of Dollar Index and has the biggest influence on dollar direction]. A rising Euro would also boost the relative performance of European stocks. The dashed line in Chart 7 plots a "ratio" of EMU Index iShares (EZU) to the S&P 500. The two lines are positively correlated. In fact, stocks in the eurozone have been outperforming the U.S. since mid 2012 when the Euro bottomed. An upside breakout in the Euro would only add to that stronger eurozone performance.
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Chart 7
BRITISH POUND TURNS UP ... More bad news for the dollar may be coming from Britain. The weekly bars in Chart 8 show the British Pound rising above its 2011 peak to reach the highest level in nearly five years. [The BP accounts for 12% of the U.S. Dollar Index]. A close above 170 would put the pound at the highest level since 2008. A rising currency is usually a vote of confidence in a country's economy and stock market. And British stocks appear to be reflecting that confidence. The monthly bars in Chart 9 show the London Financial Times Index ($FTSE) testing previous peaks formed in 2007 and 2008. A close above those peaks would make Britain the second European stock market to reach a new record high. Germany was the first.
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Chart 8
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Chart 9
BRAZIL CURRENCY LEADS STOCKS HIGHER... Countries that produce commodities stand to benefit even more from a weaker U.S. dollar (since that usually boosts commodity prices). Canadian stocks have recently climbed to the highest level in six years. Among emerging markets, Brazil is another big commodity producer that would stand to benefit from a weaker dollar and stronger commodities. That expectation may partially explain the recent surge in Brazil's currency and stocks. The blue bars in Chart 10 show Brazil iShares (EWZ) surging since March to the highest close in six months. It's being lead higher by its currency. The green line in Chart 10 shows the WisdomTree Dreyfus Brazilian Real Fund ( BZF) exceeding its October high. It's been among the world's strongest currencies over the last month. Emerging market currencies as a group have also been rising. Emerging markets generally benefit from a weaker dollar. That's another reason why the chart of the U.S. Dollar Index in Chart 5 is so important.
