You Should See the Other Guy

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That is the type of market we have right now. For every pundit that laments the growth rate of earnings or the levels of debt our consumer or government is burdened with, you can simply ask: Have you seen the other guy? Would you rather invest here now, as leading blue chip stalwarts continue to post strong earnings with attractive dividends or move elsewhere with your investment dollars? If you know what in the world is going on in Europe, let me know. The Japanese are doing all they can to destroy the Yen and Chinese growth, while still attractive, is slowing. 

Throughout the year I have kept you up to date on inflationary trends in China. I have monitored this primarily because we are its biggest importer. If things heat up in China on the inflation front, we feel it here in the form of higher prices. If growth in China reaches above trend levels, they export that to us in the form of higher prices we pay for their goods.

Earlier in the year inflationary trends in China pointed to pain here. In the past couple of years high growth rates in China led to a spike in energy prices and a hit to the collective wallet of the America consumer. As oil prices spiked well over $100 the last few years, our markets swooned.

Things have cooled off in China. Also, the Japanese have moved to reduce the value of their Yen. The recent troubles in Europe have put the Euro under pressure. These actions have made our dollar rise sharply over the past several weeks.

While the dollar has come under severe pressure for many years, there have been several times when our dollar has gone on extended moves higher. Those moves higher typically coincide with slower growth outside of the U.S. and more often with some kind of crisis abroad. When there are troubles outside of the U.S., the global investment community flocks to the dollar. This is the "best house in a bad neighborhood" argument of currency trading. As the dollar rises, inflationary pressures subside here. All of us get a boost as the things we all must buy become a little cheaper.

As inflationary pressures subside and the dollar strengthens, our market typically moves higher. There are instances every decade when issues outside of the U.S. bolster our currency. There is a high correlation between our dollar moving higher and our markets moving higher also.

With things in China cooling, it is incumbent on all of us to keep an eye on the dollar. As long as the U.S. currency remains a safe haven and earnings don’t slow significantly, our markets are poised to continue to perform.

Now let’s take a look at the technical picture of the market. The long-term trend remains very strong. On an intermediate-term basis things have weakened slightly and the near-term picture has become quite volatile.

The percentage of stocks in basing or advancing patterns decreased slightly last week. Large cap stocks are in better shape than small caps. 84% of the stocks in the S&P 500 are in good shape technically. 78% of small cap stocks are in strong positions technically. This reading is 6% off its recent high. This is a sign that fewer stocks participated in the move to new highs on the Dow last week. Also there were fewer new highs on the New York Stock Exchange last week than the prior two moves to highs.

Last week the major averages fell to challenge the support levels I gave. As some, but not all of those support levels gave way, a positive divergence developed and a rally ensued. A negative divergence set in at the end of last week as the Dow move to new highs was not confirmed by the other averages.

So, while there remains a lot more right than wrong with the technical picture of the market, things have weakened somewhat recently. Here are the support levels for the S&P 500/Dow/NASDAQ/Russell 2000: 1537/14,365/3204/936. If those levels are tested and hold, the markets should move higher. In the next advance, keep an eye to your individual holdings to see if as many of them are participating. If these support levels all give way on a closing basis, then we will see our first sustained move lower for quite some time.

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About Thomas J Smith CFA

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