July 26, 2010

US Equities vs US Dollar

(Click to enlarge the graphic).

A strengthening US Dollar, it seems, caught up to US equities; with Greenbacks now in decline, is the opposite poised to happen?

The logarithmic daily line on close charts above plot the four major US domestic equity indices versus a bearish US dollar. Left to right, top row then bottom, are the Dow Industrials (black), S&P 500 (purple), Dow Transportations (blue) and Dow Utilities (teal) indices. The red line on each chart is the PowerShares DB US Dollar Index Bearish Fund (UDN). Volume data is plotted below, and various color-coded horizontal and vertical dashed lines denote price levels and dates of interest.

Recalling our first post of CY 10, we note that the rise in US domestic equities off Mar 09 lows was coincident with a weakening US dollar (rising red line). It was remarked then that the US Dollar had pivoted in late Nov 09 and appeared to be strengthening into CY 10. That premise largely held, yet equities continued to rise after an initial stumble in early Feb 10. Indeed, highs for each index are noted by the intersection of their color coded price and date values (see dashed lines).

The outlier, of course, is Utilities, which after making a swing high in early Jan 10 has yet to recover. Though the swing highs in Utilities are now breaking out again, the index itself has been largely mired in a trading range for the better part over the past 12 calendar months dating to Jul 09. As a sector, Utilities would normally represent a defensive play, so its inability to break higher may be telling us something about the way forward. To wit, if you look at the swing highs in each of the other three indices, prices in each instrument are holding below former polarity targets originating back to pre-crash prices from Jul 08. Utilities, on the other hand, aren't even close to their corresponding levels.

It's worth noting that the bearish US Dollar held below a previous polarity level when it peaked (signifying the end of a bearish run) in Nov 09. Those levels also date back to pre-crash prices from Jul 08, in turn giving significance to the strengthening in Greenbacks seen in the first half of CY 10. A look to the current rise in the UDN (signifying a bearish US Dollar) is approaching a polarity target (not plotted) near 26.25 from Mar 10. It's in turn likely we might see the US Dollar weaken into this level only to reverse is "strong Dollar ways" thereafter.

What are we to make, then, of the rise in US equities, and the current state of volatility today? Perhaps a weakening US Dollar is the only thing holding this market up; one could make that case based upon the performance in equities from Mar 09 - Nov 09. Alternatively, however, note that the Dow Transportations index has actually broken above its Jan 10 highs. You can't find this same performance in the three remaining indices as Industrials, the S&P 500, and Utilities all remain below their corresponding Jan 10 swing highs. All of this has taken place on lower volume, the persistence of which has become "all the talk" on the street of late. This engenders caution until the US Dollar plays itself out in the next few weeks into the resumption of heavy trading following the "summer break" on Wall Street.

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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