Are Bullish Stock Indices Possible With a Higher US Dollar Index and Increasing Treasury Yields?

By Tim Thielen  JAN 06, 2014 4:05 PM

The dynamic of the last several years would say rising stocks are not likely when interest rates and the DXY are rising. Is that dynamic finally changing? The charts hint that it may be.

 


For years, there has been an inverse relationship between equities and the US Dollar – never more so than over the last five years, though. The weekly chart below shows the chart of the SPDR S&P Depository Receipts (NYSEARCA:SPY) – bottom graph -- and the Powershares DB US Dollar Bull ETF (NYSEARCA:UUP) -- top graph -- going back to late 2008, just before the worst of the financial crisis sell-off. Notice that each time the UUP is rising (red trend lines), the SPY is at best sluggish, and at worst outright bearish.   


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Seeing such a clear – although not perfect – correlation between the two makes one understand why just about every hedge fund out there using algorithms has this relationship plugged into its system as one of its go-to signals. 

So, is this going to continue to be the playbook going forward, or will the market do what it loves to do – throw the biggest mass of participants for the greatest amount of pain? Let’s go to the charts for a look.

Bonds

Treasury futures are in a downtrend still, despite current sideways consolidation. The 10-year US T-Note futures are up a bit today, but appear to be grinding through a sideways consolidation phase prior to moving even lower. Some are saying that support was found at 122’29.0 (the 138.2% Fibonacci price extension line). I can see that, but I feel that the more likely wave (iii) support is down at 122’13.5 (the 161.8% Fibonacci extension line). Overall, my read is that the trend in the short term for bond/note prices is clearly bearish, and that rates are headed higher once this very short-term correction is over. That should factor strongly into the happenings in the US dollar arena.


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Currencies

The US Dollar Index is echoing messages being sent by the Treasury futures. The US dollar has many influences, not the least of which are the happenings elsewhere in the world like Europe and/or Japan. The biggest influence, however, is obviously the relative dovishness or hawkishness of the US central bankers versus their counterparts in Europe, Britain and the Asia-Pacific region. The obvious way we measure our own dovishness or hawkishness is in the bond markets. As noted above, it appears very likely that US rates are headed higher (as evidenced by the bearish chart of 10-Year Treasury futures). With the euro and the yen both on a slippery slope very recently (despite the safety buying in the yen), the data coming out this week in the US could be very important in determining a battle between the DXY bulls and bears. Where is that battle being waged? The chart below shows that the line in the sand in the DXY battle comes in at 80.83. A close above that level will likely lead to a shot up to the bullish targets at 81.13 and/or 81.33. On the other hand, a hold of that resistance level will embolden the DXY bears – likely corresponding with a correction lower in yields. My money is on a breakout to the upside occurring either in the next couple of days or maybe after the US jobs report on Friday.      


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Equities

S&P 500 (INDEXSP:.INX) e-Mini futures are showing much more upside ahead after the correction runs its course. The S&P e-minis seem to have peaked out at year’s end and have been correcting over the first several sessions of 2014. By my calculations, at best there’s a bit more to go on the downside before the buyers come rushing back in to the market – perhaps at the 1806 level (the previous resistance level as well as the 50% retrace of the up move that started on December 16, 2013 at 1754). At worst, we could see a full retracement of that up move. Right now, I’m thinking 1806 is the level to start buying back in with uninvested cash. 

Once the correction runs its course, I am looking for a continuation of the macro bull trend with an up move that could take the minis up to around 1900. 


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Summary

So, if stocks rise, as I believe they will, are they going to do so in tandem with rising rates and a rising DXY? They very well may. As we know, there are a good number of FOMC board members (with votes) who are growing weary of seeing the market rocket higher thanks to the (artificially) low-interest-rate environment while their own stated metrics are not really presenting the results they seek. The trick will be balancing their grumpiness and a modestly improving US economy with the reality of the massive near-term uncertainties of the Obamacare rollout and the 2014 Congressional elections. And, let us not forget my previously stated macro concerns about black hole deficits and debt problems surrounding our country’s demographic trends. In my view, in an effort to continue to progress towards a more normal monetary stance while acknowledging the risks that could derail economic improvement, the Fed will continue to ease off the gas pedal (modest QE tapering) without really pressing on the brake pedal (Draconian tapering or raising interest rates). In that environment, we should be able to see equities continue higher – although perhaps not at the strong pace we saw in 2013 – as well as a gentle lift higher in both rates and the DXY. 

The key for all of us (investors, traders, managers) will be to keep an eye on the “delta.”  As long as the rate of change in rates and the DXY doesn’t get to an uncomfortable pace on the upside, this Goldilocks scenario for stocks can come to fruition. If the delta gets too big, the bears may raid Goldilocks’ party.

Twitter: @seachangereport

No positions in stocks mentioned.

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