The stock market is finishing the year out with a bang - the Dow Jones Industrial Average is up over 19% for the year while the S&P 500 has gained over 22% and the NDX has soared 48%. Will this rally continue into the 2010?
One of the biggest drivers of the market since its bottoming in March has been the U.S. Dollar. For the first two months of this year, the dollar was rising and the markets fell. But the dollar topped out in early March and that coincided with the market rally. A pretty convincing inverse relationship! So the question becomes this: Can we expect the dollar to continue falling or will its recent two-week rally continue? A continued rally could spell trouble for the stock market.
Below is a weekly chart of the DXY (DXY). You can see the dollar had been trading in a descending trend channel since early June, but broke out this week and closed above its falling resistance line.
On the chart is an indicator I use quite often in my analysis - the Forecast Oscillator (FO). Developed by Tushar Chande, the FO plots the percentage difference between the forecast price (which is generated by an x-period linear regression line) and the actual price. The oscillator is above zero when the forecast price is greater than the actual price. Conversely, it's less than zero if it's below. Actual prices that are persistently below the forecast price suggest lower prices ahead. Likewise, actual prices that are persistently above the forecast price suggest higher prices ahead. In the chart of the Dollar Index, the FO closed Friday at .80, which suggests the dollar may continue rising.
Chande also suggests plotting a three-day moving average trigger line of the FO to generate early warnings of changes in trend. When the oscillator crosses below the trigger line, lower prices are suggested. When the oscillator crosses above the trigger line, higher prices are suggested. In the Dollar Index chart, the FO crossed above its trigger line during Thanksgiving week.
In the chart, above, the FO line is solid blue. The FO Trigger line is dashed red.
Up until this week the FO was persistently below its zero line and as you see, the Dollar Index continued to fall. But the FO has been making higher lows now for almost two months and formed a bullish divergence with the Index, which had been making lower lows.
This week, the Dollar Index closed above its descending trend line, which may trigger additional new buying and/or short covering of the dollar. So how can the rising dollar played? UUP, the bullish dollar ETF, is the easiest way. Should the dollar continue to rise, it's probable that equities will fall. Or you can use inverse market index ETFs like SH (short S&P 500), DOG (short Dow 30), or PSQ (short Nasdaq-100) to make money in a falling market.
I keep close watch of the Dollar Index on my blog, www.etfroundup.com. Please stop by to read my latest comments on the Dollar Index, UUP, and other ETFs.
Dave Steckler is an investment advisor at Global Investment Solutions. In 2002 he developed the Alpha Rotation Program (ARP), a long-short market timing system using no-load mutual funds and exchange-traded funds (ETFs). He also trades a portfolio of stocks and ETFs.
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