Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

US Dollar Index on the Verge of a Breakdown

By

Risk assets such as the S&P 500 Index could be in trouble in the months ahead.

PrintPRINT
Recently I have been advising members of my service to be cautious as the market appears to be at a major crossroads. The US Dollar Index is on the verge of a major breakdown. If a breakdown occurs, it will be clear that the Federal Reserve has officially stopped any potential rise in the US dollar. Over the past few months, the dollar has been producing a series of higher highs and higher lows; however, the current cycle may break the pattern as can be seen below.



If the US dollar pushes down below the recent lows and we get continuation to the downside, we will break the recent bullish pattern. Furthermore, if the dollar starts to weaken it should benefit equities and other risk assets such as oil. Higher energy prices would not be long-term bullish for equity markets, so there is concern if the dollar really starts to extend lower.

However, if the dollar finds a bottom and rallies, it clearly would create a headwind for equities. We should know whether we have a major breakdown on the daily chart in the next few weeks. Until then, the dollar could go either way, and obviously the price action in the dollar will have a major impact on risk assets and stock market returns in the near future.

From a macroeconomic viewpoint, risk assets such as the S&P 500 Index could be in trouble in the months ahead. US gross domestic product came in lower than expected, with revisions likely in the near future. Unemployment claims appear to have bottomed and are rising week after week even though the major media fails to report it appropriately as it would appear that the Bureau of Labor Statistics has stumped media pundits with data revisions.

Additionally, there are two other macroeconomic data points that need to be mentioned. The Citigroup Economic Surprise Index has moved below zero and is showing a negative reading. This index is generally a leading indicator regarding equity prices and the recent decline shown below is problematic for the bullish case.


Chart courtesy of Morgan Stanley

As can be seen above, fundamental data is starting to skew toward the downside which is likely a result of the recession that is in the process of developing over in Europe and potentially in China. Time will tell if the index can reverse, but the bulls need to see a major reversal in the near future.

The chart below illustrates the relationship between metal prices and industrial productivity. Demand for metal increases when economies are expanding and prices generally contract when economies retract. The chart below demonstrates global metal demand. The chart speaks for itself.


Chart courtesy of Morgan Stanley

Clearly if industrial production contracts (reduction in Global Manufacturing PMI), the impact on the global economy will be felt across multiple countries' economies. The chart below illustrates the MSCI World Index compared to global manufacturing PMI. Similarly to the chart above, this chart also tells a significant story about what investors and traders should expect if the PMI numbers come in light against expectations.


Chart courtesy of Morgan Stanley

As quoted from the zerohedge.com article What Do Metal Prices Tell Us About the Future of the Stock Market?:

In other words, for those who still believe in logical, causal relationships (even in a time of central planning) unless something drastically changes to push fundamental demand of metals higher, one could say the the outlook for equities is not good.

Essentially, the data shown above is certainly not bullish in the intermediate to longer term. However, it generally takes time for macroeconomic data to permeate all the way through to equity markets. For right now, the story regarding global growth is at the very least questionable based on the data illustrated above.

In the short term, anything is seemingly possible. The S&P 500 Index closed above the key 1,400 price level on Friday. I would not be shocked to see prices extend up to the recent highs near 1,420. Ultimately I think we are in a long-term topping formation that might require another higher high up to around 1,440 before we see a deeper correction.

The past few weeks have produced a very mild correction compared to the monster rally we have seen since October 2011. This is a bullish signal, but we need to see prices continue higher and climb a serious "wall of worry" that is coming out of a variety of places. The European situation continues to worsen overall, and we have lower-than-expected GDP numbers in the US paired with concerns about growth in China.

The S&P 500 has some negative headlines to deal with, but so far it has been able to shrug off poor economic data, and we could see an extension higher that would shake out the shorts and run stops above the recent highs. However, a move lower remains possible. The daily chart of the S&P 500 illustrates the recent correction and the 1,420 highs.



I believe that the next few weeks are going to be critical, and the S&P 500 may trade in a consolidation zone between recent lows and the 1,420 highs while traders await more economic data. Fundamental data is starting to indicate that a slowdown may be beginning. In contrast, the topping pattern that we appear to be carving out may require higher prices to suck in more longs before moving into a deeper correction.

In the short run, the dollar will likely hold clues regarding the immediate future for risk assets. However, the longer-term picture for equities is quite murky based on the economic data points we are seeing paired with additional concerns stemming from the European sovereign debt crisis. Right now, I am looking at time-decay based strategies in the near term and will likely stay away from directional biased trades. I would urge readers to be cautious regardless of which direction they favor.

Editor's Note: JW Jones offers more content at OptionsTradingSignals.com.

For more on options trading, take a 14 day FREE trial to OptionSmith. Get access to veteran options trader Steve Smith's portfolio along with emailed alerts and strategy with every trade he makes. Learn more.
< Previous
  • 1
Next >
No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

PrintPRINT
 
Featured Videos

WHAT'S POPULAR IN THE VILLE