Watching Macro Indicators: The Dollar

In my books and courses I have emphasized how critical it is for equity investors to watch bonds and short-rates within a given country. Another critical macro indicator that stock traders and investors need to watch is the local currency. The currency with which stocks are evaluated in is a critical part of its valuation base.

This year, a good example of how important looking at the local currency can be in evaluating equities is shown by the French CAC 40 index. In local terms, the index is actually up around 1% for the year 2000, and technically, it doesn't look too bad. But in dollar terms, the index looks horrible technically, and it is actually down nearly 12% on the year. The bottom line is that if you want to maximize your gains, you shouldn't neglect major trends and major shifts in trends of the currency underlying equity values in the stocks you trade.

For U.S. investors, that means watching the dollar closely. The two critical things to watch for are a strong bear trend in the dollar, or a large group of foreign currencies all breaking out of basing patterns at nearly the same time against the dollar, which would indicate a change in trend in the dollar from up to down.

In the last few weeks, many major foreign currencies have either broken out of major bottoming patterns, or are close to doing so. This means that further downside action in the dollar will shift the odds clearly to the side of the dollar topping out and heading lower. A weak dollar will lead foreign investors to reevaluate U.S. stocks. It may also be an indication that foreign holders of U.S. stocks are starting to dump them -- and may, in fact, suggest and show a huge supply of stock that is being, and will continue to be, dumped on the market if the dollar continues to weaken. So watching the dollar is now critical for U.S.-based investors.

The Australian dollar (AUD) has already broken out of a small head-and-shoulders bottom. A large and major head-and-shoulder bottom will be formed if the AUD breaks out strongly over the 0.56 level. Investors without access to forex levels can also watch nearby currency futures markets for the same patterns. So far the euro, Swiss franc, British pound and Australian and NZ dollars are all forming major bottoming formations against the dollar and are close to breakout levels. If all of these currencies break out, it will be strong evidence that the uptrend in the dollar, which has been a critical component of the bull market in U.S. stocks for the last few years, is over and a new sideways-to-bearish trend in the dollar is emerging.

Here are some critical levels for investors to watch. If nearby euro futures close over 9050, nearby Swiss franc futures close over 6020, nearby dollar index futures close below 111.50, nearby Australian dollar futures close above 5600 and nearby British pound futures close above 149.00, then the verdict will be that the U.S. dollar has likely peaked. Investors should then be very wary of U.S. stocks. They should also look more favorably on foreign stocks and the technicals of foreign stocks. Bond investors should also shift out of U.S. bonds and into funds like BEGBX that favor European bonds.

A breakdown in the dollar will not be good news for U.S. stocks. Investors are advised to carefully monitor the dollar now. If all of the currency markets mentioned close beyond the critical levels indicated above, investors, should assume that the odds substantially favor that the dollar bull move, which has been a critical component of the bull market in stocks since 1995, is over.

Investors need to continue to monitor currency values, especially the local currency of the markets they are investing in. Whenever a large number of currencies all show major basing or topping patterns at the same time, and then all break out of those bases in the same direction with a week or two of each other, the odds heavily favor a new trend emerging. Investors need to be aware of new trends in currencies and learn to take advantage of them, not be hurt by them.

Stock markets whose currencies are in bull markets vs. your local currency have the wind at their backs. Investors should carefully look for strong technical trends in stocks of those currencies. Similarly, stocks denominated in currencies that are undergoing bear markets vs. most other currencies have the wind in their face. Gains are difficult and it takes an extremely powerful bull market to overcome serious currency headwinds. A peak in a currency that has undergone a very long bull market is often an indication that global investors are beginning to unwind big positions in stocks of that nation. It is therefore an indication of a potentially huge supply of stock.