DOLLAR INDEX RISES TO NEW HIGH FOR THE YEAR -- THAT'S HURTING U.S. LARGE CAP PERFORMANCE -- THE DOLLAR IS GETTING A BOOST FROM RISING SPREAD BETWEEN US AND GERMAN YIELDS -- THE S&P 500 IS HEADED FOR ANOTHER TEST OF ITS 200-DAY AVERAGE
DOLLAR INDEX HITS NEW 2018 HIGH... Chart 1 shows the PowerShares Dollar Index (UUP) rising today to the highest level since last December. It's also climbed back above its 200-day moving average and a falling trendline extending back to the start of 2017. The UUP may now be headed up for a test of its November peak. As I suggested last Thursday, the rising dollar carries a lot of intermarket implications. The most obvious implication is that a rising dollar tends to hurt commodity prices, and precious metals in particular. Not surprisingly, precious metals are leading today's commodity pullback. Energy and industrial metals are also losing ground. A rising dollar can also be negative for U.S. large cap stocks. That's because a stronger dollar makes their exports more expensive. The dollar is getting a boost from the rising spread between Treasury and European bond yields.
(click to view a live version of this chart)
Chart 1
RISING DOLLAR HURTS LARGE CAPS... The direction of dollar has an impact on how large cap stocks trend relative to smaller stocks. The red line in Chart 2 is a "relative strength ratio" of the S&P 500 Large Cap Index ($SPX) divided by the S&P 600 Small Cap Index ($SML) over the last two years. The green line is the Dollar Index (UUP). Chart 2 shows that the two lines have generally trended in opposite directions during those two years. A rising dollar during 2016 pushed the large cap/small ratio lower that year (falling red line). A falling dollar from the start of 2017 boosted large cap relative performance (rising red line) for most of that year. A dollar bottom in the first quarter of this year caused large caps to underperform (falling red line).
(click to view a live version of this chart)
Chart 2
A CLOSER LOOK AT 2018 ... Chart 3 gives a closer look at Chart 2 since the start of this year. The inverse correlation between the two lines is seen more clearly. The Dollar Index (UUP) hit bottom at the start of February when the large cap/small cap ratio first peaked. Since the start of that month, the $SML outperformed the $SPX by nearly 5 percent. The red line started falling more sharply near the end of February after the UUP hit bottom for a second time. Since the start of March, small caps have gained 2.3% while large caps have lost -2.9%. The rising dollar has had a lot to do with that.
(click to view a live version of this chart)
Chart 3
SPREAD BETWEEN TREASURY AND GERMAN YIELD HITS NEW HIGH ... The directions of currency markets are largely driven by interest rate differentials. Global money favors currencies with higher interest rates, especially if they're rising faster than others. Right now, both trends favor the dollar. Chart 4 compares the ten-year yields of Treasuries (green line), British gilt (red line), and German bund (blue line). The chart shows that the 10-year Treasury yield is much higher than the UK and Germany. What has changed over the last month, however, is that the Treasury yield has risen to three-year high, while the UK and German yields haven't (see arrows). [Over the last month, the 10-Year Treasury yield has gained 23 basis points versus a 6 basis point gain in Britain and Germany]. That widening divergence helps explain why money is flowing out of the euro and sterling and into the dollar. Chart 5 shows the spread between the 10-year Treasury and German bund yield rising to the highest level in a decade (as it has versus the British yield). That's pulling the dollar higher. And suggests that rising Treasury yields may also be weighing on U.S. stocks.
(click to view a live version of this chart)
Chart 4
(click to view a live version of this chart)
Chart 5
S&P 500 HEADED FOR ANOTHER TEST OF 200-DAY LINE... Chart 6 shows the S&P 500 nearing another test of its 200-day moving average (after failing a test of its 50-day line yesterday). Most market sectors are in the red with the biggest losses in industrials, staples, energy, and materials. A weak report on manufacturing today is taking a big toll on industrial stocks. Small caps and technology stocks are holding up better than the rest of the market.
