Will the Dollar Index Surprise on the Upside?

• S&P Breaks to a new high, but leaves a lot to be desired.
• Bond rally intact but getting overstretched.
• Dollar Index is breaking to the upside.
• Euro experiences a double whipsaw breakout.
• Gold violates a key support trend line.
• Commodities face an important test of the bull market scenario.

US Equities

Last week I concluded that the line of least resistance for equities was an upward one but that some chinks were beginning to appear in the armor.

Chart 1

Chart 1 shows that the NYSE Composite, like all the major averages, is overextended. The indicator I am using to demonstrate this is the Special K (SPK), which you can read about here. It can be plotted on the StockCharts platform, and can be plotted as any other indicator by selecting Pring’s Special K. You will need several years of data though, in order to gain some perspective. Basically the SPK combines short, intermediate and long-term momentum into one indicator that moves up and down in sympathy with the primary trend. If the security in question is revolving around the business cycle it will usually peak and trough pretty closely with the final turning point in price itself. You can see that from the arrows at the 2009 low and 2011 high. The 2011 correction was truncated, so the indicator did not perform as well. Currently it is moving in tandem with the price. Primary trend reversals are signaled when the SPK violates a meaningful trendline of 9-months or greater duration. It’s fairly obvious that the trend is still up, but it’s also evident that the indicator  is precariously balanced above its trendline. The line for the NYSE Composite is currently just above the 10,100 area, which is where the 200-day MA is currently intersecting. As long as this support holds I am not going to get too worried, but if it does give way this would represent a pretty significant negative for the market.

Chart 2

Chart 2 shows the shorter-term picture, where it is evident that the SPY has broken to the upside following the completion of a consolidation reverse head and shoulders pattern. Note that the KST, (which you can read about here) is bullish, but is not advancing that aggressively. That sets the scene for a possible negative divergence of the type that preceded the two previous minor corrections. The key support level in this case is at $186. That’s because a break below that point would confirm that this week’s upside breakout was a whipsaw and they are often followed by above average price moves in the opposite direction to the whipsaw. I am not forecasting this will happen, just preparing you in case it does. After all, we entered the five most bullish seasonal days of the month on Thursday (i.e. the last two trading days of the old month and the first three of the new one).

Chart 3

Also, Chart 3 shows that the NYSE A/D and upside downside volume lines both touched new highs this week, so there is no problem with market breadth.

Chart 4

One area that suggests a ticking time bomb comes from the bond market. Specifically the ratio between high yield and  government issues, the HYG to the TLT in Chart 4. When this series is rising it indicates investors in the bond market are growing in confidence  because they are favoring risky high yield bonds over the safety of Treasuries.  Most of the time the ratio moves in tandem with the SPY and it is not telling us much. Occasionally though,  it sets up positive divergences (at A) or negative ones (at B and C). As the market has been working its way higher in the last few weeks the ratio has been falling like a stone and has now violated a key up trendline and its 200-day MA. This relationship does not offer us precise timing , but it does put us on notice that players in the bond market, who tend to be more savvy than equity investors, have begun to lose confidence and sooner or later that is likely to feed back into the equity market.

US Credit Markets

Chart 5

The bond rally continues but the Net New High indicator in Chart 5  shows that it is getting a bit overstretched. That does not mean that bonds cannot move higher, as the false sell flagged by the dashed arrow indicates. However, most times when the indicator registers this kind of reading and then reverses, it definitely increases the probability of a correction. I am assuming the uptrend is intact unless the red up trendline, just slightly above $112 is violated.

US Dollar Index

Chart 6

The Dollar Index (Chart 6) broke above the green down trendline we looked at last week and is also above its 200-day MA. Momentum characteristics are mixed as the stochastic looks as if it’s about to roll over. The small red arrows show that this kind of action has consistently signaled corrections in the recent past.  Set against this is the fact that the slower KST has only just gone bullish and is by no means overextended. While some digestion of recent gains is quite likely I think the Index  will work its way higher, not only because of the whipsaw move to the downside that I cited last week, but due to weak action by the largest component of the Index, the euro.

Chart 7

It’s shown in Chart 7, where you can see that it made two attempts to hold above the green trendline and failed. This type of whipsaw activity is often followed by an above average move in the opposite direction to the whipsaw as traders seek to re-position themselves. Now the false break has been confirmed by the currency violating a key up trendline. Note that the KST in the bottom panel has also penetrated a line of its own and is in a declining mode. The next couple of sessions may see a bounce of some kind back to the extended green trendline in the area of 137.5, but the dye has probably already been cast for an ultimately lower euro in the weeks ahead.

Precious Metals

Chart 8

Last week I used the bullish KST for the GLD to justify higher gold prices and the probability that the red trendline in Chart 8 would not be violated. That did not turn out to be the case as the line has been decisively penetrated. I have put in the red and green arrows to show how important the line has been as a support/resistance point. Now the KST has rolled over to the downside. As long as this is the case, and the price remains below the level of the red trendline at $123 we have to take a cautious stance. Only a rally above $123 would change this balance.

Commodity Indexes

Chart 9

Last week we saw my 10-day Net New High Commodity indicator cross above its MA. The solid green arrows in Chart 9 shows that this is usually a bullish sign. This week the indicator has pulled back a little, so the price itself never confirmed with a break above the small green down trendline at $40. The line has fallen a bit, but I am still going to use $40 as my correction ending benchmark because that’s the level of the previous intraday high.

Chart 10

Finally, Chart 10 compares the CRB Composite with my Inflation/deflation ratio. This series pits an index of inflation sensitive stocks, such as resource based groups, against a similar measure of early cycle defensive issues, like banks utilities etc. When it is in a rising mode the market is voting for inflation and vice versa. The two series usually move together, but in the last few months a huge discrepancy has opened up. On Wednesday the Inflation/deflation series broke to a new marginal low. That does not look good, and to cancel this break we would need to see the ratio rally back  above its 200-day MA, the previous minor highs and the green down trendline, say to .66. That would then suggest at least a short-term victory to the inflationary side, but as long as the downside break holds, it must be considered a favorable factor for deflation senstive assets.. You can follow this series between issues:-

StockCharts Tip: The indicator can be plotted with the following combination of  symbols !PRII:!PRDI.

Alternatively, the chart will update if you click on it.

Good luck and good charting!
Martin Pring