Bullish Divergence in the Dollar

For those who are heavily long the market, I just hope that the momentum going up strengthens tonight. I am not bearish or anything but the market at this point is not something I am gung-ho about. It may go up. That is true, but the glaring question is really, how much do you expect it to go up? What is your downside for that upside you are expecting?

click to enlarge

Look at that. The VIX chart above tells us that volatility will be low going forward. My colleague in our investment group tells me that by the looks of the VIX chart, it seems that no one is buying puts. No one is hedging their long positions. The market is starting to get complacent. But beware, stability breeds instability, so they say.

Lowering prices and decreasing selling pressure is the characteristic of your coiling spring. At the same time, volume has picked up the last 4 weeks so that the support for the dollar is being established. Don't forget, the dollar moves opposite the general market. The chart already shows three points of bullish divergence. Could it be that the third time is really the charm?

Disclosure: The author does not have a position in VIX and UUP.

Comments

[Steve in TN:]

I'm betting on a resurgent dollar; so many investors are negative on the dollar. But I'm following Jim Roger's advice (I seldom do) which is if the $ starts falling fast (i.e. a crash) I'm baling out. So far my position is down 4%.

Oct 21 11:13 AM

[twitee:]

If you can not beat them you have to join them.

The magic of the recent rally will continue because there is no other place to park your money!

This is a madness......until the Credit default Swaps are regulated and financial system is overhauled the dollar will continue to go down.

There are many toxic CDS and derivatives out there....the plan is to make them to have some kind of value if at all possible by the central bankers. If the central bankers succeed, the market may go back to normal with new financial regulations......but most know it is too late and the dollar continues to collapse......we may have a up and down market, but the equity direction is only up until we correct the financial system.

Oct 21 02:37 PM

[Albertarocks:]

The importance of this article shouldn't be overlooked... it's a VERY important message.

>Don't forget, the dollar moves opposite the general market. The chart already shows three points of bullish divergence. Could it be that the third time is really the charm?<

And just to prove that the author is bang on the money, I offer this chart that I put together thanks to StockCharts. Notice how, since 2003, the "inverse" relationship between the dollar and the S&P is absolutely locked. If the dollar strengthens, this chart... and the author... suggest the markets will react to the downside. I don't think we can argue with either. Stay nimble people.
stockcharts.com/h-sc/u...

For any of you who've seen me post this chart before, I don't mean to overdo it, but I can't stress enough how important this is. I'm just tryin' to help everyone out as best I can.

Oct 21 09:14 PM

[Bryan Gomez:]

Something happend in 2003 that established this inverse relationship. Is it the internet? Is it China? Is it global trade?

Oct 22 12:31 AM

[Albertarocks:]

On Oct 22 12:31 AM Bryan Gomez wrote:

> Something happened in 2003 that established this inverse relationship.
> Is it the internet? Is it China? Is it global trade?<

I don't know that there is a specific "one answer" to that question, and I only have a theory. I'm not an expert.

I get the impression that the secular bull market in the economy itself, and in the stock market as well, ended in 2000 rather than in 2007 as is the accepted notion. Michael Clark's theory (which I now completely agree with and which I'm trying to expand upon) is that during a bull market (a "real" bull market), a strong dollar is a product of a strong economy and results in a strong stock market and overall confidence in the USA in the eyes of foreigners. So in that scenario a strong dollar is all-around good for basically the overall health of the economy in general. Actually, a strong dollar is the "product" of the truly strong economy.

But in a faltering economy, the dis-connect starts to appear between the dollar and the markets. The dollar starts to fundamentally weaken partly because the economy itself is fundamentally weakening, but the stock market hasn't figured it out yet. It's almost as if the stock market took off on its renewed upward trajectory in 2003 oblivious to the fact that the dollar was weakening until... until the day that 2+2 finally equals 4 once again and the equity markets begin to behave "somewhat" rationally. They start to pay attention to what the dollar is doing and react accordingly. The stock market begins to become reactionary, rather than just running amok to the tune of those who manipulate it. The day arrives when it all has to make sense... when the markets have to face the music as it were. Man, it's a long process though.

The transition appears to have taken place between about 2001-2003, and in 2003 the transition completed. From that time forward, the relationship became inverse. At first there was a little bit of "slack" in the relationship, but as time advanced, that "slack" even disappeared. It eventually evolved to the situation we have today, where there's no slack left. If the dollar is supported, the stock market IS going to come down. At least, that's what the chart is telling us.

The further into a recession we go, the more frantic the relationship becomes... or the more concretely the inverse relationship becomes locked. I think the chart shows beyond much argument that in 2006, the inverse relationship became absolutely forged and locked together to the point now, where if the FED even "dares" to support the dollar, the stock markets would react immediately and in lock-step (inverse lock-step). If the dollar strengthens, the markets will fall. It didn't use to be that way, but that was a different time, a different era, and a totally different economy.

So the FED is now in a pickle. They're damned if they do and they're damned if they don't. But in either case, they'll be damned, which is what they deserve. They earned that fate decades ago.

I wouldn't discount one other scenario that might be entirely possible. It's possible that the inverse relationship could be broken and we could see the dollar and the stock markets once again move in tandem rather than inversely.... but both down at the same time. This would be a rather disasterous scenario to say the least. That would mean an inflationary scenario, but where the stock market crashes along with the dollar. Normally an inflationary scenario would theoretically result in rising prices of everything, including the equity markets. It appears that the FED is not going to support the dollar. It appears that the stock markets are already at such lofty levels that money is simply flowing out of the US markets and into foreigh markets. Yeah... I think we could see the scenario where the dollar, the economy and the stock markets could crash at the same time. It would be a period of inflation with a sick economy.

I wonder if I've just written my thesis on what "stagflation is"?

I honestly don't know. It's 3:30 a.m. and I'm tired. I'll write the exam tomorrow.

Oct 22 05:29 AM

[Bryan Gomez:]

Thanks for the concise answer. The chart you presented tells a lot of untold story.
Anyway, the only thing going for the US is that because of a weak dollar, their products become competitive in a global market and this would eventually be positively incremental to their trade. Remember that its major index, the Dow, is comprised of approximately 40% earnings coming from operations overseas. I think the demand for US goods from overseas will never wane until those things can be bought and manufactured in their local markets. Money created lifts standards of living overseas. It seems that this is the path the US is taking. Their weakness in the dollar is buying them time.

I am not going to debate you on this but it seems that your stagflation thesis is well thought out. I would like a copy if you want a fresh look at your theory. The simplest solution that I think can bring them out of this burden and align the strength of their economy with the strength in their currency is only through innovation. Standards of living is close to being leveled, information democratized, and the US has to step up once again and create something that has never been created before. They have to set that noveau standard of living.

Oct 22 09:03 AM

[Albertarocks:]

On Oct 22 09:03 AM Bryan Gomez wrote:

> Thanks for the concise answer. The chart you presented tells a lot
> of untold story.<

You're welcome, but Bryan I'm serious that I'm only an amateur.

I was joking about the "thesis". I'm only learning as I go along here and only now is it starting to more or less all make sense to me... sort of.


> Anyway, the only thing going for the US is that because of a weak dollar, their products become competitive in a global market and this would eventually be positively incremental to their trade. Remember that its major index, the Dow, is comprised of approximately 40% earnings coming from operations overseas. I think the demand for US goods from overseas will never wane until those things can be bought and manufactured in their local markets. Money created lifts standards of living overseas. It seems that this is the path the US is taking. Their weakness in the dollar is buying them time.<

I agree on all counts.

> I am not going to debate you on this but it seems that your stagflation
> thesis is well thought out.<

I assure you, I'm in no position to debate because truly I am an amateur.

>The simplest solution that I think can bring them out of this burden and align the strength of their economy with the strength in their currency is only through innovation.<

I'm not sure they're going to be given the chance. Fascism is raising its ugly head. And I'm not impressed with the implementation of "czars". That's nothing short of insanity.

Oct 22 05:16 PM