The last few months have been unkind to stocks, but lately we’ve seen buyers step in and provide support.
Dow Theory recently turned bearish, but looks to have reversed that signal on Friday. Below we see both averages confirming one another as they trace out new short-term highs. Let’s walk through the price action in more detail.
On August 25th both the Industrials (top chart below) and the Transports (bottom chart below) provided renewed bearish confirmation by setting simultaneous new lows. From that point we saw a reaction rally that peaked out on September 16th for the Industrials and September 17th for the Transports.
From there the averages resumed their descent but bottomed on September 28th, with each average remaining above its prior low. This set the stage for another leg higher.
The Industrials were the first to rally above their prior high and did so on October 5th, indicating the transition to a bullish trend of rising peaks and rising troughs (higher highs and higher lows). On Friday of last week the Transports achieved the same milestone, thereby confirming the Industrials and indicating a shift in trend back to the upside.
As you’re well aware, much of the rebound has been predicated on a weaker dollar and strengthening commodity prices. The chart of the US Dollar Index below highlights the recent weakness in the buck, and if you look at the moving averages, you can see that a death cross (50-day moving average crossing below the 200-day) will inevitably occur in the next few days.
This bearish technical signal may set the stage for further downside pressure, which will continue to be received well by equity and commodity markets.
But we’re by no means out of the woods. A Fed rate hike is still on our doorstep, Washington may cause some apprehension with government shutdown concerns, and few of the macro headwinds have abated.
Interestingly, with regard to a US rate hike, many emerging market central bankers are pushing for the Fed to take action, arguing it will remove uncertainty from the markets.
At an IMF meeting in Lima, Peru, the case was made that uncertainty around the timing of the first rate hike is causing repeated bouts of volatility in both emerging market currencies and capital flows. Many central bankers seem to feel that embracing Nike’s slogan, “Just do it” will help to ease these concerns.
It’s true that markets hate uncertainty, but I’m not as convinced that a Fed rate hike will ease emerging market woes. As far as removing uncertainty, the question will simply become: Will the Fed raise rates again? And when?
Many of these central bankers are banking on the notion that a rate hike will drive the dollar higher. This is debatable, as we saw that generally not to be the case during the last rate hike cycle. But if you expect the dollar to rise, then from a trading partner perspective, US tightening is an alternative route to domestic easing.
The one bright spot in all of this is that the Fed has telegraphed this rate hike beyond all expectations. Typically it is unforeseen events that upset markets, not developments that have been in the making and on center stage for years. This has given both investors and emerging markets time to prepare and adjust their positions accordingly.
Perhaps Ilan Goldfajn, chief economist at Itau Unibanco, summed it up best in a recent WSJ article when he said, “Nobody can say they were caught by surprise. That said, markets are crazy.”
The preceding content was an excerpt from Richard Russell's Dow Theory Letters. To receive their daily updates and research, click here to subscribe.
