Dollar Bear to Take a Breather?

• The Bear Market Case
• Time for a Counter-Cyclical Rally?

The Bear Market Case

By most methods and approaches, the Dollar Index is in a bear market. Take Chart 1, for instance, which compares the Index to its long-term KST. The pink-shaded areas tell us when it is below its 12-month MA and the KST is also under its 9-month MA. Sometimes, such as the 1999 example, this condition only lasts for a few months; usually, however, it's much longer. This technique went negative a couple of months ago, causing the Index to drop precipitously below its 2011-2020 up trendline. That's pretty serious stuff, which suggests that the US Dollar is in the early phase of a bear trend.

Recent price action has also taken on the characteristics of a bear, as we can see from Chart 2. This one compares the Index to its 9-day RSI. During a bull market, psychology is positive, which means that short-term oscillators tend to trade in a higher range than during bear markets. Bull markets also see the oscillator tending to stay in an overbought condition for a longer period. By the same token, downside action is far more limited. That's what the green and red parallel lines are trying to demonstrate. It is fairly evident that the RSI has recently been trading closer to its bearish 2017-2018 range than the bullish 2018-to-early 2020 one. This exercise, like the technique in Chart 1, does not tell us how long or deep the bear will run. Until proven otherwise, though, it is wiser to assume the primary trend is negative.

Chart 3 features several relationships that tend to move in the same direction as the Dollar, which I call "dollar sympathy" indicators. When they are simultaneously moving in the same direction, it tends to reinforce technical signals triggered by the Index itself. On the other hand, disagreements indicate subtle strengths or weaknesses that question the direction of the Index. In the last few weeks, the inverted commodity and US/International bond ratio have fallen in "sympathy" with the Index, but the S&P/ MSCI Europe Australia Far East (EFA) ratio has not, thereby casting some doubt on the Dollar's weakness.

However, it's important to remember that the S&P has recently been dominated by a select number of high-flying tech stocks. If we substitute the more broadly based NYSE Composite and the Vanguard World ex the US ETF (VEU), a different, more consistent picture with a Dollar bear market emerges. Note that both the ratio and the Dollar have completed upward-sloping head-and-shoulders patterns. Moreover, the KST for the ratio has gone bearish.

Time for a Counter-Cyclical Rally?

Whilst the case for a primary Dollar bear is quite strong, it's important to note that primary trends do not generally move in straight lines; rather, they tend to experience more of a zigzag path. The evidence shows that if a counter-cyclical rally is going to take place, now would be as good a time to expect it as any. That view is based on the fact that sentiment has moved decisively to the bearish side. For example, there have recently been a number of bearish Dollar articles appearing in the financial media. In addition, bullish Dollar traders, as monitored by several sentiment surveys, are recording very low numbers, which, from a contrary point of view, is positive. Commitment of traders reports have Euro hedgers at a record short position and the Dollar Index at a high and vulnerable reading. Hedgers are usually correct at turning points. Those extremes are not yet outright bearish for the Euro or bullish for the Dollar; after all, there is nothing stopping these numbers moving to even more of an extreme. It does strongly suggest that, when their trend actually reverses, that will be time when the Dollar can expect a boost.

Chart 5 compares the Dollar Index to our Dollar Diffusion indicator (!PRDIFCUR), an oscillator that monitors a basket of cross-dollar relationships in a positive trend. As you can see, it has just gone bullish.

Chart 6 shows the same indicator, but from a longer historical perspective. The green arrows show upside reversals that have taken place from an oversold reading. Dashed arrows represent weak signals; these tend to develop under a pink shaded bear market environment, as is currently the case. There are two takeaways. First, the indicator's recent upside action hints at a rally. Second, expect a relatively weak advance or rangebound activity. Only if this is a bear market low should we expect anything more robust, but right now the vast majority of primary trend indicators are pointing south.

Finally, Chart 7 featuring the Euro supports the possibility of a temporary Dollar peak. Remember, the Euro has a 57% weighting in the Dollar Index, so its trajectory largely mirrors that of the Index. The first thing to note is that the currency is well above its rising 12-month MA and the KST is decisively bullish. However, it is just below the 2008-2020 down trendline. That line represents very significant resistance, not only due to its length and relatively shallow angle of descent but because it has been touched or approached on numerous occasions. It would not be unreasonable to anticipate some kind of a pause at this important potential barrier.

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 Groupof Walnut Creek or its affiliates.