Sentiment Speaks: Can A Weak U.S. Dollar Really Push The Dow Higher?

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Includes: CRF, DDM, DIA, DOG, DXD, EEH, EPS, EQL, FEX, FWDD, HUSV, IVV, IWL, IWM, JHML, JKD, OTPIX, PPLC, PPSC, PSQ, QID-OLD, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RWL, RWM, RYARX, RYRSX, SBUS, SCAP, SCHX, SDOW, SDS, SFLA, SH, SMLL, SPDN, SPLX, SPSM, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU-OLD, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TNA, TQQQ, TWM, TZA, UDOW, UDPIX, UPRO, URTY, USSD, USWD, UWM, VFINX, VOO, VTWO, VV, VXX, XIV
by: Michael Golembesky

Summary

Recent price action.

Anecdotal and other sentiment indications.

Price pattern sentiment indications and upcoming expectations.

Recent Price Action

After hitting the 161.8 extension up off of the April 18th lows on July 14th The Dow Jones Industrial Average has moved sideways and has traded in a very tight range of less than 1% since that July 14th top. Furthermore, the pattern both up and down off of that July 14th high has been a very sloppy not giving us very much information to work with on the smaller time frames.

This very tight range in the Dow and the other major Stock indices has contributed to the record breaking low Volatility levels that we have seen over the past week which I wrote about in this article. While these record low levels of Volatility are certainly extreme and a Volatility “reset” would be welcome by many, for now, the Dow along with the rest of the US equity Indices are still holding over key support levels and have not signaled that a top is in place just yet.

Anecdotal and Other Sentiment Indications

Ever since the market bottomed in January of 2016 the pundits have been looking for that bombshell news event that was surely right around the corner causes the market to crash. From Brexit to Trump to Russia, there has been no shortage of black swans to go around yet the market just kept on plugging away higher and higher. as we are approaching the target levels that we had set out back in the early part of 2016 when the Dow was trading almost 40% below current levels we begin to see the pundits abandon their black swan theories and start to come up with new theories of how this rally can simply continue to move full steam ahead. So while not surprising, the fact that we are seeing these articles come out now as we are approaching our target zone for this large move up off of the 2016 lows is still fascinating.

As we are approaching the target levels that we had set out back in the early part of 2016 when the Dow was trading almost 40% below current levels we begin to see the pundits start to abandon their black swan theories and begin to talk about all the exogenous events that will cause this rally in stocks to continue to move full steam ahead. So while not surprising, the fact that we are seeing these articles come out now, after the Dow has moved up 40% off of the 2016 lows is quite fascinating.

As I also cover the Foreign Exchange Markets in addition to the Equities and Volatility markets I find it quite frustrating when I see articles and analysts discuss how a weakening US Dollar should help move stocks higher such as the one that was recently published below:

“U.S. stock market could get powerful tailwind from weaker dollar: Morgan Stanley”

The theory behind this argument is that a weaker dollar will make the goods of US Companies less expensive in overseas markets thus increasing earnings of those US companies. Which will then, in turn, cause the stock prices of those US Companies to move higher; thus causing the stock market as a whole to rise.

While I certainly understand the argument behind this theory and it certainly sounds like it should make sense, it simply has never proven to actually be the case in reality. There is no long term historical correlation between the value of the US Dollar and that of the US Stock Market. More frustrating is that all one has to do is simply look at a chart of the US Dollar overlaid on top of the equity chart to quickly prove this theory invalid.

DXY OVER DXY OVER 2

As is evident by the charts above it is quite clear that sometimes stocks move up when the US Dollar Moves up, sometimes stocks move up when the US Dollar moves down, sometimes stocks move down when the US Dollar moves up and sometimes stocks move down when the US Dollar moves down. Again there is simply no long term correlation that justifies the argument that a “weakening” or weak dollar is good or bad for stocks.

Yet despite the hard data disproving the theory that a weak US Dollar is good for the US Stock Market, this remains to be accepted and the common belief among most market participants and we hear this same argument repeated time and time again.

What is occurring between the US Dollar and the US equities markets is two different markets sometimes have similar sentiment patterns that will align with each other and at other times will be in complete opposition to each other. These overlapping sentiment patterns will then result in times when there is a positive or negative correlation to each other. Of course, there will also be instances when there is no strong matching sentiment in either direction during which times these two separate markets will simply show no correlation whatsoever.

So while it may make for a nice headline to state that a weak US Dollar can help to push the stock market higher, in reality, the only thing capable of pushing stocks higher, or lower for that matter, is the changing sentiment of those who are speculating in the stock market itself.

Price Pattern Sentiment Indications and Upcoming Expectations

As there has been very little change this week in the movement of the Dow the forward looking analysis from last week has also changed very little. As I noted last week:

From a purely structural standpoint and with the high that was made on June 14th, we now have what could reasonably be considered a completed pattern in place, and although I would still prefer to see the ideal target zone of 21,971 – 22,429 hit prior to topping; any break of the 21,084 level should be viewed as an early warning sign that a top in the Dow may be in place. Further confirmation of this top would come with a break of the 20,981 and finally the 20,553 level.

Once this larger degree top is confirmed we can more accurately define the support zone for the next move lower but at current price levels that support comes in at the 20,063 – 19,311 zone. Given the structure of the second wave of the same degree, I do expect the next corrective move lower to be somewhat deep; so these are very reasonable levels to expect to see the Dow hit prior to bottoming in its next corrective move lower. A move down into these levels would represent a move of 8-12 percent and given that we have not seen a corrective move of any significance since last fall this is a relatively large move in the Dow.

So regardless of whether the dollar is weak or strong or we see more “scandal” come out of Washington, as long as we are over the 21,084 level the Dow is still likely to see another high prior to topping. Once that larger degree top is made we then will focus our attention on the longer term support zone noted above and keep an eye out for a bottoming pattern that would give us the signal that we will still see yet another push higher into 2018.

Dow 4 Hour Dow Daily

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have no direct positions in the tickers mentioned but I am currently long some various US stocks via options.