October 22: Market Update for the Dollar, Equities, and Commodities

US Dollar
The dollar continues to perform so, so poorly.  Below is a 3 month chart...

All indicators are oversold or very, very close to it (RSI has some downside).  The euro broke above $1.50 today, but the  dollar has held that 75 level, which is within 1% of the 75.83 support line (in red above, often referred to as the 76 support line).  In fact, though, the price activity is very bearish.

The blue lines on the chart point to a couple of things of interest.  The first is the very well defined downtrend in the dollar, shown between the two parallel blue lines, since the beginning of October.  The trend began when the dollar was overbought on the slow stochastic (and at the 50 resistance level in the RSI).  We are now oversold on the slow stochastic and very close to it on the RSI.

There is another blue line that, along with the top blue line of the channel, forms a triangular pattern.  It all points to the 75.00 level.  It is quite clear that any chance of even a short term rally in the dollar must happen before that triangle is broken to the downside, which will break the down trend channel to the downside (even more bearish) and invalidate the 1% range.

Frankly, we think it's going to happen, and there will be a rally now at 74 that is a bit stronger than the rally at 76.  Nonetheless, we do not believe there will be a substantial rally until the dollar is in the 70-72 range....

Equities
As we've pointed out before, we believe the S&P could reach 1350, though nothing fundamental really supports this.  However, since we first made that prediction in June, it now appears to be a more realistic opportunity that one would have originally imagined.

Nevertheless, there are major obstacles between here and there that bear watching.  The chart below points to some key levels to keep in mind.

The blue horizontal lines mark the Fibonacci retracement levels between the October 2007 top and the March 2009 bottom.  On a weekly basis, the next few key resistance levels will be:

- 1100 (round number, not marked on the chart)
- 1124 50% retracement from the lows.  This is a key level of possible failure in the rally.
- 1230 61.8% retracement from the lows.  This is, in our belief, the most likely failure point before 1350.
- 1350 (red horizontal line) Target of the inverse head and shoulders pattern

Of course, the market can turn over at any time, but these are the levels which would need to be watched on a longer term basis.

Note that the S&P is approaching overbought on the weekly RSI.  This has not happened since September/October of 2008.  If there is going to be a major pullback in the markets, it will probably happen when the S&P is overbought on the weekly RSI, it is near a key resistance level (noted above), and the dollar is near a strong support level (72 likely, but possibly 74).  Until then, smaller pullback are possible, but probably nothing significant (barring a credit market lockup).

Note on the chart below, the inverse correlation with the dollar is still strong.

If anything, the dollar is overextended to the downside more than the S&P is extended to the upside.  This negative divergence can be taken two ways:  the S&P need to be lower/the dollar needs to be higher, or the correlation between the two is breaking down.  We are watching this carefully.  At this stage, we believe that the dollar is oversold here and is still within the 76 range enough for a small rally.

Shorter term, we can see this breakdown in correlation in yesterday's market action as the dollar fell, and so did stocks.  We would need to see this trend for a while to determine if there is a decoupling process occurring.

Note that stocks have been trending up between the two blue lines since late July.  Given that we're near the upper range of that trend, with a minor dollar rally we should see the S&P touch the lower end of the trend channel before a rebound.

The important sector of the market to watch are the banking stocks, which are also in a trend channel.  Banking stocks took this market down, and there can be no sustained general market rally without them rallying first.  We may see a bit more downside, but we believe that we will see a rebound in the financials at the lower end of the trendline, which will move the general market back up.  A break below 45 on the BKX banking index will signify that a correction to the 40 level--at least--will be underway. 

Note that key foreign equity markets bottomed around 1 year ago, in late 2008, while the US market bottomed in March of 2009--approximately 6 months later.

In the case of Brazil and India, not only did they bottom first, but they have been strongly outperforming the S&P ever since. China bottomed in the same timeframe, and after outperforming, has recently been underperforming the S&P.  However, we believe there are some flaws in the Shanghai Composite Index relative to external investment opportunities, and prefer to measure China by some of the ETFs that track companies available on the Hang Seng index that are available to foreign investors.  Of the available ETFs, which include the popular FXI, the FCHI, the PGJ, the CAF, and the GXC, we prefer the GXC as it has a reasonable mix of large cap and mid cap companies in the most diversified sector economies and is not a closed end fund, like the CAF (see this article--interesting review on the CAF).  That chart looks a bit different from the Shanghai Composite:

You can see that it has all of the characteristics of the Brazilian and Indian markets, including continual outperformance against the S&P since the end of the credit crisis.  It is our belief that these markets are now the leading global indicators for market growth opportunity, and that the US will follow them.  The only outperformance by the US (or European) markets should be as a result of a panic. 

Note that all of the emerging markets (as well as Australia and Canada--other important proxies) are now showing as overbought, or very close to it.  Whenever we have a significant correction, we believe it will start with these emerging market players and then spread to the US and Europe.  Any significant pullback in any of these emerging markets or commodity producing markets will be a good buying opportunity, barring a global credit market lockup.

Perhaps the best measure of global market strength is the Baltic Dry Index.  Although off its best 2007 levels, the BDI is improving steadily--a sign of improving global economic strength.

Commodities
As we discussed in September, the Continuous Commodities Index is our preferred general commodities barometer, which is 17.64% energy, 17.64% grains, 11.76% livestock, 29.4% soft commodities, and 23.52% metals.  In the same report, we discussed the impending breakout in commodities.  While the target price has not yet been achieved (but we believe it will be after a small consolidation), the action in commodities prices since that call has been tremendous.

The longer term chart shows the substantial gains and target prices much better.  Of interest are the Fibonacci levels retracing the lows to the highs.

The breakout occurred at a key Fibonacci level, with a price target that should take us to another key Fibonacci level.  Given that commodities just broke through the 50% retracement level, the interesting price action should occur near the target level 0f 500.

Our pattern price target should take us to the 500 level, which is also a key Fibonnacci level that may be the point of a significant pullback.  Prior to that level being achieved, we believe that the 468-470 level will serve as support for any minor pullbacks.

Just to keep it honest, you can see the dollar/commodity inverse correlation below:

Relative to the dollar slide, commodities appear to be slightly overbought.  Expect a few dull days in commodities before the second half surge to the upside, and the 500 level on the CCI.