Will the market peak soon? Watch the dollar
By
Dominic Frisby Nov 16, 2009
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On August 31st, we saw the peak for the year in the Japanese stock market. The Nikkei 225 hit its 2009 high at 10,767. It has been in decline ever since.
Then in mid-September, the Toronto Stock Exchange made its 2009 peak. Next it was the Australian Stock Exchange, which peaked in mid-October at 4,897. The French and German exchanges followed a few days later.
Yet last week the US indices and our own FTSE 100 somehow made it to new highs, albeit by just a few points. How can this be?
Global stock markets are peaking
Of course, it's partly down to currency weakness. The countries with the weakest currencies – the US and the UK – have seen more extended runs in their stock markets, while the countries with stronger currencies have peaked sooner.
Looking at the US indices, there are some notable divergences now appearing. For example, although the general indices are higher, the US banking index, the BKX, topped at 49 in mid October. Since then it is down some 10% or more. That's not a good sign for the bulls – banks have a tendency to lead the rest of the market. For example, pre-credit crunch, the BKX peaked back in February 2007, but it took until October for the rest of the indices to peak.
The Russell 2000 Small Cap Index also peaked in mid-October and is looking weak. The Dow Jones Transports are also below their October highs, as are the Utilities, although by just a few points. Having peaked in October, the percentage of stocks on the S&P 500 trading below their 50-, 100- and 200-day moving averages is increasing. In other words, the broader indices are being pushed higher by just a few popular stocks, such as Google. Most sectors are edging down, regardless of the weak dollar.
I wrote recently about the importance of a major trend line coming down off the stock market highs of 2007. The S&P 500 bounced back last week to retest it at around 1,100. So far, as you can see below, the trend line has held – just.
The German DAX (see below) and Hong Kong's Hang Seng index managed to break through their equivalent lines earlier in the year and move higher…
…but this same line is now proving a barrier elsewhere in the world – in Australia and Japan (see below), for example.
And in London we have not even made it to retest that barrier (see below).
Why you must watch the US dollar
I cannot emphasise enough just how important the US dollar is in all this. Look at the chart below. It shows the US stock market, the S&P 500, on top, and the trade-weighted US dollar index below (this shows the value of the dollar against the currencies of its most important trade partners). As you can see, over the past 18 months, when one rises, the other falls, and vice versa.
So a reversal in the seemingly ever-falling dollar could change everything. Stock markets, commodity markets, gold, junk bonds, the euro – you name it – could all reverse with it. And many of those markets are currently sitting at technical inflection points – in other words, they all look vulnerable to a major turnaround.
For now, the 75 level on the US dollar index is holding, but barely. A break below 75 on the US dollar index would most likely coincide with a move above 1,100 on the S&P. But if 75 holds and the dollar heads higher, the bounce in stock markets is over.
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Is another slump nearly here?
'The trend is your friend… until the end', as the trading saying goes. The trend has been up, but if this is the end, perhaps we need some kind of catalyst in the news to propel a reversal. Foreign exchange trader, Kathy Lien, has observed how G7 meetings of finance ministers and central bank governors often seem to coincide with significant tops, bottoms and trend reversals in the US dollar. She has put together this interesting chart, which shows the US dollar against the euro, and how it has performed after various G7 meetings.
Of course, we had just such a summit last weekend in St. Andrews, (with the G7 now expanded to G20). Will that mark a reversal in the dollar at around 75 on the US dollar index? If it does, then part two of the Credit Crunch will soon be showing at a screen near you.
If it doesn't, and stock markets push higher, we bears must have a rethink. But in that scenario, with the dollar continuing to weaken, you can expect gold to keep heading higher too. I've written in more detail about gold's bull run in the current issue of MoneyWeek: A bite from the gold bug is good for your wealth – if you're not already a subscriber, you can claim your first three issues free here.
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