POSSIBLE UKRAINE CEASEFIRE LIFTS GLOBAL STOCKS -- RUSSIAN AND EUROPEAN STOCKS JUMP -- CHINA LEADS EMERGING MARKETS -- DOW INDUSTRIALS AND TRANSPORTS TEST OLD HIGHS -- RISING DOLLAR HURTS COMMODITIES
RUSSIAN STOCKS JUMP 5% ... News of a possible ceasefire in Ukraine has given a big boost to global stock markets. Nowhere is that more evident than in Russia. Chart 1 shows the Market Vectors Russia ETF (RSX) jumping more than 5%. The Russian ETF needs to clear its mid-August peak (at 25.45) to turn its short-term trend higher. That would put it above its 200-day moving average line as well. Russian tensions have taken a heavy toll on eurozone stocks, especially Germany. Stronger Russian stocks is translating into stronger European stocks as well.
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Chart 1
FRENCH AND GERMAN STOCK INDEXES IMPROVE... Last Saturday's message showed a close correlation between German and Russian stocks. It's no surprise then to see both rising together today. Chart 2 shows the Dow Jones Germany Stock Index ($DEDOW) climbing more than 1% and trying to climb back over its (red) 200-day line. Chart 3 shows the Dow Jones France Stock Index ($FRDOW) having already done that. While today's geopolitical bounce is encouraging, the eurozone still has to deal with an economic slowdown and the threat of deflation. Tomorrow's announcement from the ECB on monetary policy will also have a big influence on the direction of eurozone stocks. An ECB announcement of some form of quantitative easing could give stocks an added bounce. Failure to do so could have the opposite effect.
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Chart 2
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Chart 3
CHINA STOCKS EXEND BULLISH BREAKOUT... The Russian rebound is also giving a boost to emerging market stocks. So are rallies in the three other big emerging market countries that are Brazil, China, and India. Of those three, India has been the strongest. The top line in Chart 4 shows the Wisdom Tree India ETF (EPI) trading at a three year high and up 34% this year. The blue line shows Brazil iShares (EWZ) at a one-year high and up 23% this year. The red line shows China iShares (FXI) jumping to a three year today and up 11% for the year. [China iShares are up 3% today on strong economic data]. The black line shows Emerging Markets iShares (EEM) also trading at a three-year high. The EEM rally is being led by upside breakouts in three of its biggest components. The fact that the EEM 2014 gain is a smaller 9.9% is due to a -13% drop in Russian stocks. The EEM has also outpaced 2014 gains in the U.S. (8.3%) and foreign developed stocks (2.8%).
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Chart 4
DOW AVERAGES CHALLENGE RECORD HIGHS ... U.S. stocks are also rising today with the S&P 500 reaching a new record high. Two other widely watched U.S. stock indexes are trying to set records as well. The hourly bars in Chart 5 show the Dow Jones Industrial Average testing its July intra-day high at 17151. It exceeded that level briefly a week ago but the issue is still in doubt. The hourly bars in Chart 6 show the Dow Transports also testing their July intra-day peak. Since the transports are the more economically-sensitive of the two Dow averages, a close in new record territory would be a positive sign. According to Dow Theory, however, both Dow averages need to close in new highs to confirm the continuation of the current uptrend.
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Chart 5
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Chart 6
RAILS HIT NEW HIGHS WHILE AIRLINES DIP ... The attempt by the transports to hit new highs is complicated by diverging trends in two of their biggest components. The daily bars in Chart 7 show the Dow Jones Railroad Index trading well into record territory,. That's where most of today's transportation strength is coming from. Airlines, however, are taking a drubbing today owing to a strong rebound in the price of crude oil. The daily bars in Chart 8 show the Dow Jones U.S. Airlines Index down -3% today and stalled at its June peak. Weakness in airline stocks is going to make an upside breakout much more difficult for the transportation Index.
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Chart 7
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Chart 8
RISING DOLLAR IS HURTING COMMODITIES... My last message showed the US. Dollar Index rising to the highest level in a year. One of the usual side-effects of a stronger dollar is weaker commodity prices. The weekly bars in Chart 9 show the Dollar Index (green bars) and the CRB Commodity Index (solid area) trending in opposite directions over the last three years. A dollar upturn in late 2011 coincided with a big drop in the CRB Index. Another dollar upturn in late 2012 contributed to more commodity weakness. It's no surprise then to see that the dollar upturn starting this summer has coincided with a drop in commodity prices. It's pretty difficult for commodity prices to rise in the fact of a strong dollar. Two of the hardest hit by the dollar rise have been gold and oil. Chart 10 shows the price of crude oil (black line) plunging -11% during July and August as the dollar rose 4%. The orange bars (top of chart) show gold also falling during those two months (-4.6%).
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Chart 9
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Chart 10
RISING TWO-YEAR TREASURY YIELD ALSO FAVORS THE DOLLAR... Divergent monetary policies between the Fed (which is ending QE) and the ECB (which may be just starting QE) is supportive to a stronger dollar. [The level of interest rates is a barometer of economic strength, and one of the main factors in currency direction]. Nowhere is that divergence between the U.S. and Europe more evident that in the difference in short-term yields between the two regions. Chart 11 shows the 2-Year Treasury Yield rising over the last year to a three-year high of 0.53%. By contrast, the 2-year Eurozone yield is a negative -0.02%. Five of the 18 eurozone countries have negative two-year yields (including Germany). Short-term yields are more sensitive to central bank policy than long-term yields. The divergence between rising two-year yields in the U.S. and negative yields in the eurozone reflects a stronger U.S. economy relative to Europe (and the potential for tighter Fed policy). While tomorrow's ECB announcement may cause some short-term currency volatility, interest rate trends (both short and long term) continue to favor the dollar.
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Chart 11
FALLING EURO MAY MAKE DEFLATION WORSE... One final thought on commodities, currencies, and ECB policy. The biggest reason for the recent dollar rally has been the plunge in the Euro. Since commodities trend in the opposite direction of the dollar, they trend in the same direction as the Euro. Chart 12 shows the commodity plunge this year starting shortly after the Euro started tumbling during May. The 60-day Correlation Coefficient (below chart) shows a strong positive correlation of .82 between the two. Here's the potential problem. Any action by the ECB to weaken the Euro to combat deflation would push the dollar higher. That would push commodity prices even lower. [Global commodities are priced in dollars]. Mr. Draghi recently stated that most eurozone deflation is the result of falling commodity prices. A weaker Euro, and higher dollar, resulting from ECB policy could combine to make commodity deflation even worse.
