January 11, 2010

S&P 500 vs the Australian Dollar

The first week of trading in the New Year rang hopeful. With all the buzz around the "January Effect," where can technicians look to identify dips?

The daily chart above plots the S&P 500 (purple bars) and the Australian Dollar spot (black line on close) in the top section. The lower section of the chart plots a black ratio line resulting from the S&P 500 divided by the Australian Dollar (aka, S&P priced in Aussie). Blue vertical dashed lines mark pivot dates of interest, and blue horizontal dashed lines denote price pivots. Lastly, red and blue arrows denote polarity price targets in the S&P 500 itself.

Perhaps the surprise feel good story of last year was the bounce in US equities. Last week, we reviewed the relationship between a rising S&P and a falling US Dollar. Here, we look for clues as to buying dip behavior in the index itself. Concentrating on the top cash portion of the chart, the S&P has risen almost unabated since Mar 09. But for mild respites in Jul 09 and Nov 09, new highs have been plentiful. Looking purely at price, these "dips" are not readily apparent. Indeed, a Fibonacci retracement grid drawn between Mar 09 - May 09, and again Jul 09 - Aug 09, provided little opportunity to join the trend.

Priced in Aussies, however, the ratio line in the lower half of the chart provides far better clarity. Fibonacci grids drawn between the aforementioned swing periods did reveal price support for the S&P 500 near the 61.8% retracement level - but technicians would have to look beyond pricing equities in US Dollars to identify these levels. Instead of merely buying these retracements visually, however, technicians would have been better served to wait for a polarity trade (prior resistance becomes support) to enter the trend.

An entry based on the ratio price of the S&P 500 in Aussies (approximately 1,129 in Jun 09, and 1,264 in Oct 09) would have been premature. Instead, taking a preemptive trigger from these retracements would have alerted technicians to look for a subsequent pivot. Entries that best represented good risk managed trades were near 875 (hit in early Jul 09) and 1,018 (hit in Oct 09). These price levels represented good polarity trade values of each swing, and are plotted for each with a pairing of red (for prior resistance) and blue (for new support) arrows. For those accustomed to entering purely on price, any number of filters (not drawn) would have served as valid confirmations. For example, trend lines drawn from the peaks in both Fibonacci grid pivot highs would have worked nicely.

Unspoken in this analysis is the ongoing dilution in purchasing power in US markets. Clearly, volatility is far more evident priced in Aussies than in Greenbacks. Whether or not the US Dollar can sustain the rally discussed in recent weeks will speak volumes about the direction of US equities as a whole. Those who continue to hold a bullish bias to the S&P 500 are not likely, however, to easily identify those buying opportunities merely priced in US Dollars. Technicians should instead price US Indices in other currencies, and subsequently seek to identify support using polarity price levels. The Aussie appears to be yielding the best signals, and serves as the leading instrument for consideration.

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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