Friday, December 4, 2009

Observe the Power of the Dollar on the Stock Market

It looks like yesterday's late day sell off was just profit taking and protective posturing for the jobs number that came out today because the major indices rallied to new highs and the Nasdaq confirmed the Dow and S&P's highs from yesterday, which eliminates the short term bearish non-confirmation. The longer term divergences remain in solid place.

Today's better than expected jobs numbers has everyone doing cartwheels on TV about the economy and the stock market. However the dollar has rallied sharply this morning as you can see from the AUD/USD and EUR/USD charts attached which move opposite the dollar. The stock market rallied huge this morning but so did the dollar. The stock market's rally could not fight the huge headwinds that a dollar rally brings, mainly because most of the rally from the March 2009 bottom was due to dollar weakness to begin with. It was just an inflationary rally in prices, not a fundamental underpinning of strength in the market. So the Dow went from a strong triple digit gain this morning to negative territory where it sits today.

I, and many others, have been saying for a long time that the key to the stock market's rally and decline is the dollar. A dollar rally will result in a stock market decline, and vice-versa. If today's reversal holds, we'll see if it has legs and runs next week. But the fact that people sold good news and the dollar rallied on a great jobs report is definitely bearish, especially because the past several months have brought rallying on jobs report day. A change in recent trends are another sign of a top, and today we have another piece of evidence supporting that.



JD said...

From an untrained eye; todays DJIA is declining impulsively and currently looks to be in a 4th wave. 12:51pm ET

Todd said...

It does look impulsive, but it needs to further subdivide lower to eliminate the possibility of it just being another ABC zig-zag decline, where the A and C waves are composed of 5 waves.

Good observation JD.


Dave427 said...

Todd - Yes, I see the dollar trending lower since March and the overall market trended higher, so there is an inverse realtionship. I take it you are saying that the rally was based on the slipping dollar, at leasst one factor, maybe the biggest. But what would it take for the dollar to rally? It seems with our huge and growing debt, the likelihood of a continuing anti-business and anti-free market environment, what would make the dollar stronger? Is it that it might simply be stronger than other currencies?

My novice view is that the social mood is still in an post-election Obama-Glow positive mood, hence the rally. As time goes on, the Obama-Glow will fade when the mass public realizes that the current agenda is opposite of what it needs to be to lower unemployment and foster overall growth. When the social mood becomes sour, the market will fall.

Todd said...

Hi Dave, yes dollar inflation appears to be a big driver of higher stock prices from the March 2009 bottom. Elliott Wave International also has a chart of the stock market priced in gold and the rally from March is feeble at best, hinting that the majority of the rally was based on dollar weakness, and that only stock prices have really risen, not necessarily any fundamental or intrinsic value to the stocks. So when the dollar bottoms, the stock market should top. The forces of a stronger dollar on equities will be too much for the bulls to fight.

What would make a stronger dollar would only be temporary, maybe a year or two. Elliott Wave International reports a bearish extreme in sentiment on the dollar suggesting it's a very crowded trade. A panic in the financial markets will have investors running for safety, which means buying US dollars, US treasuries, and repatriating their foreign investments back into US dollars. This can cause a dollar spike and will have overleveraged dollar bears cover their shorts in a panic that can shoot the dollar higher for a while. Once that's over, the dollar should resume its downtrend. But the spike in the dollar should be huge, about 2,500 pips at least in the USD/CHF. My opinion.

And you're right about social mood, however I think we're a bit more advanced in a souring social mood than you're putting forward.

We'll see.

Good stuff, Dave, thanks.