TRANSPORTS STILL DIVERGE FROM INDUSTRIALS -- DJ COMPOSITE AVERAGE IS TESTING 200-DAY AVERAGE AND IS GOING TO NEED HELP FROM THE TRANSPORTS AND UTILITIES TO RESUME ITS UPTREND -- DOLLAR UPTURN INCREASES NEED TO HEDGE FOREIGN CURRENCY RISK
INDUSTRIALS NEED SOME HELP FROM THE TRANSPORTS... I remain concerned about the negative divergence between the Dow Industrials (black bars) and the Dow Transports (red bars). The discrepancy between the two Dow Averages is the biggest in three years. That may not pull the Industrials lower, but it may prevent them from moving higher. At the very least, it's hard to imagine the Dow Industrials resuming their uptrend without some help from the Transports. The ideal situation is for both Dow Averages to be moving up together. Which brings us back to the Dow Jones Composite index which may be giving the most accurate picture of the U.S. stock market.
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Chart 1
DOW JONES COMPOSITE AVERAGE RETESTS 200-DAY AVERAGE ... As you know, I've been focusing on the Dow Jones Composite Index (DJA) in recent messages. The DJA includes all 65 stocks in the three Dow Averages -- 30 Industials, 20 Transports, and 15 Utilities. I believe the Dow Composite Average gives a truer picture of the stock market than any of the three Dow Averages by themselves. Chart 2 shows the DJA peaking last December, and trading sideways since then. The reason for its flat appearance is the different performance in the three Dow Averages. While the industrials have gained nearly 2% this year, transports have lost -8% and the utilities -5%. Normally, the market is stronger when all three Dow Averages are moving up together. For that to happen, the Dow Composite Average needs to be in an uptrend. So far, no serious chart damage has been done to the DJA. However, it is trading near the bottom of its 2015 trading range, and is testing its (red) 200-day moving average. [The Dow Transports and Utilities are below their 200-day lines]. It's important for it to hold in that major support area. It would be even better if it could climb above its May peak at 6436. For that to happen, it's going to need more help from the transports and utilities.
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Chart 2
DOLLAR TURNS UP... It looks like the recent downside correction in the U.S. dollar has run its course. Chart 3 shows the PowerShares US Dollar Bullish ETF (UUP) climbing back above its 50-day average this week (on rising volume). Its 14-day RSI line (top of chart) has turned up from oversold territory near 30; and daily MACD lines (below chart) have turned positive. A stronger dollar has a lot of intermarket implications. For one thing, it's bearish for foreign currencies most of which fell yesterday. The Japanese yen fell to a new seven-year low (more on that shortly). It's also bearish for commodities and stocks tied to them. That includes metals and energy stocks. Weaker commodity prices are negative for commodity exporters like Brazil, Canada, and Russia. A stronger dollar may also cap gains in U.S. multinational stocks that depend on foreign business. [A weaker oil market, however, may benefit transportation stocks. More on that shortly]. While weaker foreign currencies may help foreign stocks, a strong dollar hurts foreign stock ETFs that are priced in dollars. More importantly, a stronger dollar increases to need to hedge foreign holdings for currency losses.
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Chart 3
FALLING YEN INCREASES NEED TO HEDGE CURRENCY RISK ... I've written several times over the last year about the need to hedge currency risks when investing in foreign stocks in Europe and Japan. That's especially true when their currencies are falling. That's because foreign currency losses offset profits made in foreign stocks. Nowhere has that been more true than in Japan, where a plunging yen over the past couple of years has helped make Japanese stocks among the strongest in the world. [A falling yen helps Japan's export-oriented economy]. During the first five months of 2015, a relatively flat yen may have tempted some investors to abandon the currency hedge. That didn't make much of a difference during the first five months of the year when the yen traded flat against the dollar. Chart 5, however, shows the yen plunging to a new seven-year low against the dollar this week. That makes a currency hedge all the more necessary.
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Chart 4
WISDOMTREE JAPAN HEDGED EQUITY ISHARES HITS NEW HIGH... Chart 5 compares Japan iShares (EWJ) to the Wisdom Tree Japan Hedged Equity iShares (DXJ) since the start of the year. The EWJ is quoted in U.S. dollars, while the DXJ hedges out the currency impact. As a result, the DXJ has done much better than the EWJ over the past couple of years. Both rose together during the first five months of the year as the yen traded flat against the dollar (and the Japanese stock market rallied). This week, however, the DXJ has jumped to new high, while the EWJ is still below its April high. Both are rising, but the DXJ is rising faster. That's because the EWJ is being held back by a weaker yen. Chart 6 shows a relative strength ratio of the DXJ divided by the EWJ since last October. The Wisdom Tree Hedged ETF/EWJ ratio peaked last December when the yen started to stabilize. This week, however, the DXJ/EWJ ratio surged to a new high. That was caused by a simultaneous plunge in the yen. Meanwhile, Japanese stocks have risen to a new 15-year high. If you're going to invest in Japan, the DXJ is a stronger bet than the EWJ.
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Chart 5
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Chart 6
ENERGY FAILURE... My May 7 message carried the headline: "Selloff In Energy Shares May Suggest Oil Peak". I drew that analysis from the fact that the Energy Sector SPDR (XLE) started backing off from its 200-day moving average -- as shown in Chart 7. Since energy stocks often lead turns in the price of oil, I suggested that oil might be peaking as well. Both have weakened since then. The fact that the XLE has fallen below its 50-day average (blue line) suggests more selling to come. The dotted line shows the price of crude oil (USO) starting to roll over as well. Chart 8 shows that the dollar peak during March coincided with a bounce in crude oil. The May dollar upturn has had the opposite effect by pushing the price of oil (and most other commodities) lower.
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Chart 7
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Chart 8
FALLING OIL MAY HELP AIRLINES... If crude oil prices are starting to weaken again, that might help airline stocks which are one of the most fuel-sensitive parts of the market. And they could use some help just about now. Chart 9 shows the Airline Index ($XAL) trying to find some support near its 200-day moving average. At the same time, its 14-day RSI line (top of chart) is trying to bounce from oversold territory near 30. This is most oversold reading for airlines since last October when the group rallied. The airline peaks in January and March coincided with upturns in crude oil (solid line). Any downturn here in the price of oil may give airlines a much needed boost. That might also help relieve the negative divergence between the Dow Industrials and Transports.
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Chart 9
TECHNOLOGY LEADS MARKET HIGHER... Stocks are bouncing back back from yesterday's heavy selling. Technology is leading the way. Chart 10 shows the Technology Sector SPDR (XLK) trading 1.5% higher and nearing a new 15-year high. Its relative strength line (top of chart) is rising as well. That's normally a good sign for the rest of market. Semiconductors are leading the sector higher, thanks largely to a 20% surge in Broadcom (BRCM).
