Bearish Dollar Index Signal Has Major Implications For All Kinds Of Markets And Relationships

• Changes in key relationships
• Implications for specific stock sectors of a declining dollar
• The US versus the world

At this week’s Market Roundup webinar, I suggested that we had reached an inflexion point for many markets as well as several Intermarket and inter-asset relationships. That inflexion point centered on a change in the primary trend of the US Dollar Index. You could argue that it’s these relationships and their influence on the dollar that is important. Others might say that the dollar itself is the driving force. Whichever way the argument falls the big news is that we have seen tentative signs that some key relationships have begun to reverse and that these changes in money flows will have important investment implications.

Changes in key relationships

Charts 1 and 2 compare the dollar to what I call “dollar sympathy indicators”. These are relationships and markets that rise and fall with fluctuations in the dollar. Monitoring them offers a useful cross check against the Index itself. For example, if the dollar drops below its 12-month MA and this is confirmed by several of these sympathy indicators the odds of the bearish dollar signal are enhanced and vice versa. In Chart 1 for instance, we can see that two of them have confirmed the trend break in the Dollar ETF.  The third, the relationship between the US stock market and the dollar based rest of the world in the form of the MSCI Europe Australia Far East ETF, the EFA, is right at its up trendline. I’ll take a look at that relationship and its implications later.

Chart 1

Chart 2 contains monthly data. The two relationships below the dollar have been plotted inversely to correspond with its movements. The series in the middle window is a credit spread, which compares the performance of high-quality bonds to ones of lesser quality. A rising relationship means that bond investors are losing confidence and vice versa. Since a rising ratio corresponds with a rising dollar it means that one of the driving forces for the currency is its safe haven status.  On the other hand, a falling relationship tells us that bond investors are growing in confidence. That tends to be bullish for stocks, the economy, emerging markets and commodity prices. “Risk on” as they say. Right now that ratio is right on its 12-month MA, so the jury is still out. Also, the latest plot is an estimate as the final data will not be available until the end of the month.

The indicator in the bottom panel is the ultimate inflation/deflation relationship since it shows whether commodities are outperforming bonds.  When they are, it’s inflationary and shows up as a declining trend for this inversely plotted series. Its fluctuations fit with the idea that a declining dollar is inflationary and vice versa. This ratio also has an estimated April 29 end-of-the-month plot, but based on recent action has fallen marginally below its 12-month MA. Since this is a series that’s not included in the StockCharts database, I’ll be sure to update it in the next article as a breakout will have significant implications for several Intermarket and inter-asset relationships.

Chart 2

Implications for specific stock sectors of a declining dollar

If a falling dollar is going to act as a tailwind for commodity prices, it would be reasonable to expect equities that benefit from such a development to be acting favorably on both an absolute and relative basis. In this respect, Chart 3 compares an index comprising resource-based sectors compared to one consisting of deflation and defensive issues. I call it the “Inflation/deflation” ratio. When it’s rising you want to be exposed to inflation beneficiaries and vice versa. Since the ratio has recently cleared the two converging trendlines, the 65-week EMA, and the short-and-intermediate KSTs are rising, it seems to me that the ratio is headed much higher in favor of inflation beneficiaries. How far will it go? I don’t know, but probably long enough to trigger a long-term KST buy signal and give us a bull market or mini-bull market.

Chart 3

One of the components if the Inflation Index is gold shares, so it’s not surprising that they look quite promising.  Chart 4 shows that the long-term KST for the Market Vectors Gold Shares, the GDX, has reversed to the upside on both an absolute and relative basis. More to the point, both the absolute and relative lines have violated down trendlines and crossed above their 65-week EMA’s.

Chart 4

Chart 5 shows another inflation beneficiary, the Spider Energy ETF, the XLE. It looks poised to go positive and awaits a bullish signal from both KSTs. That’s likely to come because the violation of the two down trend lines indicates that negative momentum has begun to dissipate.

Chart 5

Compare that performance to the more defensive healthcare sector represented by the XLV, where the KSTs are in a declining trend and the price and RS line have violated major up trendlines.

Chart 6

The US versus the world

One of the dollar relationships that is currently right on the line is featured in Chart 7 as the SPY/EFA ratio. As you can see the short-term KST has completed a top and broken down. Its intermediate counterpart has just gone bullish. The long-term momentum is still positive but barely so. It’s obviously in a very finely balanced technical situation. That means that a decisive trendline violation by the ratio itself would tip that balance to the downside and an extended period when the US underperforms the rest of the world in dollar terms.

Chart 7

If we look at three important global regions, we see that none, in relative terms, have given buy signals yet. However, things may be getting pretty close to breakout time. For example, the Spider Europe 350 is hugging its 2014-16 down trendline for relative action and the relative KST has gone completely flat. A valid upside breakout would likely reverse this momentum indicator to the upside.

Chart 8

We see exactly the same thing for the Japanese ETF, the EWJ, except that the RS downtrend is far more impressive as the trendline has been touched on numerous occasions and is 6-years in length. A break above $13.50 by the price itself would complete a 16-year consolidation pattern and be super bullish for Japanese stocks denominated in US dollars.

Chart 9

Finally, Chart 10 features the MSCI Emerging Markets ETF, the EEM. Here again, we see a 5-year downtrend in relative action and a relative KST poised to go bullish. If the SPY/EFA ratio and the RS lines in Charts 8, 9,and 10 violate their respective trendlines, look out for a significant relative swing away from US equities.

Chart 10

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.