January 4, 2010

US Domestic Equities vs Bearish US Dollar

The year rings anew, and hope abounds for US equities - but has the future already been foretold?

The four daily line on close charts above plot (left to right, top row then bottom) the Dow Industrials, S&P 500, Dow Transportations, and Dow Utilities. Overlaid in red on each chart is the PowerShares US Dollar Index Bearish Fund (UDN). The indices are plotted to the right axis; the bearish dollar ETF to the left. Color matching trend lines and volume (accompanied by a median horizontal dashed line) are also plotted for each index. Blue vertical dashed lines denote bullish pivots in equities markets, and a single red vertical dashed line denotes a recent bullish pivot in the bearish dollar ETF.

Most glaringly obvious on these charts is that US domestic equities have risen since Mar 09 against a backdrop of bearish dollar sentiment. As the UDN ETF rises, the value of the US Dollar decreases (that time period highlighted in red above). But for a modest correction in late Spring 09, and a consolidation in early Summer 09, the US Dollar was ravaged for much of the past year. This followed a period of modest strength going into the sell off finale in equities during Mar 09.

Overlaid to one another, however, technicians will note a distinct breakdown in the aforementioned relationship. As the Dollar strengthened in Dec 09, US equities continued onward to set new relative highs. This followed a period of consolidation in the Oct 09 - Nov 09 timeframe, with each index exhibiting somewhat different behavior off the 02 Nov 09 bullish pivot. The Dow Industrials, as well as the broader S&P 500, gained initially, yet tapered off - indeed limping to newer highs as the year ended. While more volatile, the Dow Industrials exhibited nearly the same behavior.

Independently, the Dow Utilities experienced a longer consolidation period, breaking out from an Aug 09 - Nov 09 trading range in setting a stronger high than the others. Looking to volume, both the Dow Industrials and S&P 500 rose largely on the backs of fairly calm volume in 09. The Dow Transportations and Dow Utilities followed suit as well, but note the difference in volume spikes as the year came to an end. Volume in both the Dow Industrials and S&P 500 tagged spike highs in mid Dec 09, as did the Transportations and Utilities - yet an increase in volatility in the latter two indices were evident as early as Oct 09.

Looking ahead, the most worrisome aspect of this chart is the decoupling between the US Dollar (now turning short term bullish) and the aforementioned indices. Gains in US domestic equities can, in part, be attributed to the incidental attractiveness of US products and services relative to the purchasing power of foreign nations. Perhaps this trend can continue - perhaps it cannot. But few technicians will dispute equities are rising amidst weakened strength. Multi-month trend lines in all but the Dow Industrials above have been broken, and only the Dow Utilities are impressing to the upside. This is decidedly defensive, and serves as a cautious start to the New Year.

It was noted last week that US Treasuries are signaling a possible forthcoming rise in US interest rates. As technicians, we have a bevy of data available to use in positioning for for the New Year. Commodities have been largely dormant (with modest exceptions), and the Federal Reserve is intimating it is ready to pursue a tightening policy with at least limited Treasury sales in the weeks ahead. After a terrific bounce off Mar 09 lows, investors - both institutional and private - will surely seek to address systematic risk. It's not unlikely that at least some players will sell into the phenomenal strength of last year, and reallocate to other asset classes. Accordingly, risk controls and total market exposure should be monitored closely in the months ahead.

Jeffery E. Lay, CMT
President
Talon Eight, LLC

Disclaimer: This post is intended solely to disseminate information, and is not, and shall not be construed to constitute financial, investment or other similar advice. All posted material should be independently verified for accuracy and current applicability. Readers of this post are referred to the Risk Disclosure for further information.

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