Tuesday, January 19, 2010

Expecting the Dollar Index To Rise For 2010

In 2009, investors were down on the US Dollar, and anytime the US Dollar was down, everything else was up. But as we head into 2010, the US Dollar appears to have found support above the all time lows made around $70 in March, 2008 and reversed higher. There is reason to believe that from a technical perspective this reversal is for real, and it is real enough that it should have implications for other markets.

Figure 1 is a monthly chart of the Dollar Index (symbol: $DXY). The "next big thing" indicator is in the lower panel. We note that in March, 2008 the Dollar Index found a bottom (red down arrows on chart) while the indicator was in that zone that suggested a secular trend change was likely. The subsequent up move was more like a bounce (within an ongoing down trend) than a secular upward price move, but more importantly, the lows from the 2009 down draft have held above the prior pivot point low seen in March, 2008. December's 2009 strong move in the Dollar Index, resulted in a positive divergence bar; these are the price bars labeled with the pink markers. This positive divergence bar is significant for three reasons: 1) we know that positive divergence bars represent slowing downside momentum; 2) we also know that they tend to lead to a trading range with the highs and lows of that positive divergence price bar being the extremes of that range; and 3) positive divergence bars are often seen at market bottoms prior to secular trend changes.

Figure 1. $DXY/ monthly

The important point is this: the low of the positive divergence is support, and this is at 74.27 on the $DXY. This becomes our line in the sand, and a monthly close below this level is not a good sign for the green back.

Figure 2 is a weekly chart of the $DXY. This chart shows our normal pivot low points (black dots) and the special key pivot points which are those pivots that occur when sentiment towards the Dollar Index is bearish; these are the yellow and black dot pivots. In general across multiple assets, a close above 3 normal pivot points is bullish; this has not happened yet for the Dollar Index but a weekly close above 79.46 would meet this criteria. In general across multiple assets, a close above 3 key pivot points is bullish; this has happened. And viewed by this lens, 2009's down slide was just a pullback in a bull market for the Dollar Index that began in 2008.

Figure 2. $DXY/ weekly

So within this context, I am bullish on the Dollar Index.

The questions to be asked are the following: 1) why is the US Dollar going higher?; and 2) if the US Dollar is going higher, how can we use that information?

Why is the US Dollar going higher? Despite all its drawbacks, the Dollar remains the world's reserve currency and safe haven. Low short term interest rates and the Fed's and Treasury's pension for devaluing the currency at the expense of inflating assets are real concerns, but several analysts have suggested that slowing or non-existent economic growth in 2010 will trump these concerns. Money will seek the safety of the greenback, which will be viewed as the best of the worst - i.e., better than other paper currencies.

How can we use this information? 2010 could be the year of capital preservation. A higher dollar implies a struggling economy, which should be a headwind for equities, both domestically and internationally. The same could be said for commodities. After such huge gains for equities and commodities in 2009, a period of consolidation seems likely. A rising Dollar seems to the perfect foil for the equity and commodity markets.

This also seems to square with my 12 month analysis for the S&P500. Over the next 12 months, I am bullish on the S&P500, but it will be important to buy low and sell high or buy when investors turn bearish on equities and sell when they are bullish. We should get those opportunities in 2010.

8 comments:

D-man said...

Pfff...difficult!

"Why is the US Dollar going higher?"

Your points are valid; there is another one, for the LT investor. The greenback is in a bear for 19 years now; secular bears last 15-20 years. At some point they stop; with paper money is more difficult as they are subject to political decisions, but the same can be said about T-bonds.

"A higher dollar implies a struggling economy, which should be a headwind for equities, both domestically and internationally."

Well, I don't know. A healthy market moves up with its currency. A market which relies on cheap credit is subject of crashes like we saw in the last decade. A higher dollar can suggest a growing US economy when compared to other economies.

"A rising Dollar seems to the perfect foil for the equity and commodity markets...

Over the next 12 months, I am bullish on the S&P500..."

I thought you prefer commodities over equities; did you change preferences? I'm aware of your S&P analysis.

"...but it will be important to buy low and sell high or buy when investors turn bearish on equities and sell when they are bullish. We should get those opportunities in 2010."

Well, let's hope so; in 2009 sentiment didn't help us except in March as this was a time when despite extreme bullishness there were no really buying opportunities.

Thanks for the post!

Guy M. Lerner said...

Hi D-man:

Yes, difficult or unusual "call" let's say but more importantly, I am having a hard time knowing what to do with that knowledge; meaning that I could go out and buy the UUP or the Dollar up ETF, but that doesn't move much; so it is more like an academic exercise of what does a rising dollar mean.

I would agree that no country has ever devalued its way to prosperity so a rising currency is generally good for that country, but we are in the race towards the bottom as far as paper currency is concerned; emerging markets, commodities, and US equities face a headwind I believe in 2010 and maybe it is global growth that is slower than desired which leads to the Dollar being a safe haven.

Did not change preferences but both equities and commodities will need to consolidate gains of past year; the higher dollar will be a manifestation of slowing growth and this will not be commodity or stock friendly. Therefore, important to wait for sell offs and buy at the lows.

D-man said...

Speaking of difficulties, how's the messy bond trading functioning? You must be bullish on those by now :)

thanks

Guy M. Lerner said...

Well I am long IEF (in size) and it is looking better by the day; I would like to get long the greenback but other than UUP do you have any suggestions on how to play it? For now it is more like avoiding foreign markets and precious metals, etc

D-man said...

"I would like to get long the greenback but other than UUP do you have any suggestions on how to play it?"

What's wrong with UUP? Short copper...

Guy M. Lerner said...

UUP has the volume but the % gains are not likely to be significant enough; in other words, I would have to take out such a large portion of my portfolio that I am unwilling to make such a concentrated bet

I have looked at EUO, which is a proshare (2x ETF) that is long but shorts the Euro

Now by proxy, metals and all such should be going down and that was the crux of yesterday's question of what to do with this information....or what does a higher dollar mean?

Onlooker said...

Deflation. I know it's anathema to all the inflationists, again, but you can't have such a blind spot. It killed them in 08 and could do so again.

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