U.S. Dollar: Double Top or Double Bottom?

Fri, Oct 19, 2012 - 2:41pm

Since the middle of this summer, the stock market has generally traded up while the USD has been trending down. However, beginning in September the stock market stopped advancing and the USD stopped declining. Given the strong inverse correlation between the stock market and the USD Index, keeping an eye on the USD may shed light to the market’s next intermediate-term move.

Currently a Bullish and Bearish Case for the USD

As can be seen below, the USD Index and the S&P 500 have a strong negative correlation between them (Note: USD shown inverted). Currently it looks like the USD is bottoming (topping in chart) and the S&P 500 is peaking. If we continue to see strength in the USD Index then we are likely to see our first intermediate top in the markets since the March highs.

Source: Bloomberg

Taking an unbiased viewpoint, one can easily make a bearish and bullish case for the USD. The bearish case shows a bearish intermediate trend that has been in place since July where the bears took a breather over the last month as the USD Index traded in a bearish flag formation (parrellel green lines) that also shows a short term double top (solid red lines). However, a few days ago the USD Index broke the flag support and appeared to be resuming its bearish intermediate trend. Over the last two days the USD Index has rallied to test the upper trend line of its bearish intermediate trend channel and so far the bears still maintain control and a failure at this point for the USD to continue advancing would likely be followed by a sharp move lower which would likely lead to higher stock prices.

Source: Bloomberg

The bullish slant when looking at the USD Index would argue a “W” bottom is in the works and that the USD likely bottomed. For the bullish argument to be confirmed we would need to see the USD Index clear its late September to early October highs just over 80.00 and then close above its 200 day simple moving average. If this occurs we would like see further weakness in the stock market.

Source: Bloomberg

As of now we do not know which way the USD will go as either outcome is plausible at this point, but we shouldn't have long to wait since the USD is currently bumping up against its upper bearish trend channel. If we do get further USD weakness then we are likely to see the stock market and commodities advance, while the opposite is true.

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Chief Investment Officer
chris [dot] puplava [at] financialsense [dot] com ()