U.S. Dollar: The Investment that Might Be About to Bottom

As I’ve noted several times on these pages, the US stock market and US dollar are trading at a near perfect inverse correlation. With stocks extremely overbought and reaching a critical point of potential resistance, any bounce in the dollar could kick off a rapid collapse in the US stock markets.

Which is why I’ve noted with great interest that the dollar is showing signs of a potential short-term bottom. The below chart details the US dollar (black line), S&P 500 (purple line), and their respective 21- and 55-day moving averages.

First and foremost, I want to point out that the S&P 500 could easily fall to test its 21-day moving averages (1,060) and the dollar could rally to test its 21-day moving average (77.34) in the very near future. This would certainly fit will with my theory that we will see a brief correction in stocks in the next week.

However, one item that really interests me is the fact that the dollar actually rallied both INTO and AFTER the Fed’s FOMC meeting.

As you can see, the US dollar rallied strongly from September 16-21. You’re probably wondering how I can claim the dollar was rallying when it collapsed on September 21. Well, you should know that the collapse that occurred on the 21 came from an article that Reuters’ forex columnist wrote based entirely on his OPINION, not any real announcements.

On Tuesday, Reuters reporter Neil Kimberly wrote a piece stating that President Obama will push for more dollar depreciation in the G20 meeting currently taking place in Pittsburgh. I want to point out first and foremost that the article is cited as Kimberly’s “opinion” not fact. I also should like to note that even Kimberly himself states that there will be no “explicit” call for dollar debasement.

Last week I commented that we are reaching a point of “desperation” for stocks: a time in which investors are so desperate to believe the “bull story” that they will spin any and all news items to reinforce their beliefs. The Neil Kimberly article and subsequent collapse in the dollar illustrate this fact like nothing else. Here we have an “opt-ed” piece by a reporter who has no factual basis for his claims of further dollar debasement and yet the dollar tanked and stocks rallied.

The desperate side of this story comes from the fact that the dollar had begun a four-day rally prior to Kimberly’s piece. And it quickly reversed and rallied the day AFTER the article came out. Even more importantly the dollar rallied AFTER the Fed’s FOMC announcement in which it stated it would continue to fight the financial crisis with a “wide range of tools.”

Put another way, despite the Fed clearly stating it will continue to pump money into the system and maintain various anti-dollar policies, the dollar actually RALLIED. If that is not a sign of a potential bottom, I don’t know what is (remember bottoms come on bad news, just like tops come on good news).

Looking strictly at the dollar index chart can be misleading because it represents the dollar’s value against a basket of world currencies. For more specific directional insights, we need to consider the dollar’s individual chart against specific main currencies like the Japanese Yen and the Euro.

Well, the dollar/yen is showing signs of potentially having broken out of its downtrend…

Similarly, the euro/dollar chart is closing in on a line of historic resistance.

Both of these charts (as well as the overbought nature of US stocks) bode well for the dollar. I’ve said time and time again that Bernanke will have to sacrifice stocks or the dollar. We’re now literally within a week or two of seeing which investment class will roll over. Either stocks will be rejected at their 88-weekly moving average and the dollar will rally (kicking off a wave of risk aversion) OR the dollar will sink to potentially test its low of 71 on the dollar index and the S&P 500 will explode higher to 1,200.

With only 3% of investors bullish on the dollar, the stage is set for a real surprise here.

Good Investing!

Comments

[Steven Hansen:]

Graham, both the dollar and equities are defying gravity.

it makes you wonder whether there are unseen forces at work. when things do not make sense, usually there is something we do not know.

Sep 29 05:21 AM

[markfl:]

There have been a number of seemingly inconsistent statements from FOMC members lately. They seem to be telegraphing fractiousness next year. I think there are clearly some investors that feel the FOMC is being disingenuous about fighting a weak economy at the expense of anticipatory tightening. Someone may have their ear to the ground as to whether the Dr. Jekyll or Mr. Hyde FOMC plans to show its face and think they know something the MSM doesn't.

Sep 29 07:08 AM

[nova:]

The US policy is to drive its stock markets up at all expenses (including debasement of US$).

Falling US stock markets will put insurmountable pressure on US banks, insurance companies and pension funds. US ruling elite cannot allow it to happen short of committing a political suicide.

Sep 29 08:23 AM

[Bad Dog:]

Take a look at Zoellick's comments in today's paper. The USD is weakening simply because there are choices of other currencies that offer a path to somewhat lower risk. The USD has to be perceived as a slightly higher holding risk today in view of the significant debt overhang in the US both public and private. To the extent that Americans have to tighten their belts to pay off their debts, the USD will reflect that. Of course, having a slightly weaker USD is useful to that end up to a point. The weaker USD makes US equities that much more attractive to foreigners.

Sep 29 11:27 AM

[Robert Mart...:]

Graham,

"Bernanke will have to sacrifice stocks or the dollar." That's insightful and succinct, and I believe he is sacrificing the dollar.

I'll grant you that the dollar is ripe for a bounce. As you noted, sentiment is overwhelmingly bearish, and the USD rallied recenlty on bad news. But let's put this anticipated bounce into perspective.

Stocks and the USD have been inversely correlated for much of this year because the dollar benefited from a flight to safety. The dollar benefits from fear because it's the global reserve currency. So, even as the U.S. devalues its currency with unprecedented monetary and fiscal stimulus, the dollar defies gravity. Nevertheless, I believe an inflation hedge and a dollar hedge are a must for long-term investors. seekingalpha.com/artic...

For now, the Mother of All Liquidity Rallies is driving stocks, commodities and the real economy. The dollar has not declined for the reasons cited above, but I remain a long-term bear, and believe a declining dollar will exacerbate the inflation created by massive monetary and fiscal stimuli. What's worse, the stimuli are not creating jobs, so we are seeing a rise in populism and protectionism. I describe it as "The Deflation of the American Dream" seekingalpha.com/artic...

______________________...

Steve Hansen:

"Both the dollar and equities are defying gravity. It makes you wonder whether there are unseen forces at work. When things do not make sense, usually there is something we do not know."

Well said! This is a guiding principle of mine. My favorite way to use technical analysis is as a sanity check for fundamentals. A technical break without a fundamental reason is a torpedo alert.

Be well,
Rob

Sep 29 12:50 PM