The Dollar might have reached a short-term low

Editor’s note: this column was originally published on Capital Essence’s CEM News on October 07, 2007. It’s being republished as a bonus for the loyal readers. For more information about subscribing to CEM News, please click here.

Good Morning. This is Capital Essence’s “Market Outlook” (the technical analysis of financial markets) for Monday October 08, 2007.

As we’ve opined in the previous Market Outlook: “the larger picture remains unchanged – we have a strong market that is poised for a breakout to new high”, equity market rose sharply Friday with the S&P finished at a new all-time closing high amid a “Goldilocks” job report. Any SPDR S&P 500 ETF (SPY) call option traded could have made a triple digit profit.

Before Friday’s opening bell, the Dept. of Labor reported an increase of 110K in September nonfarm payrolls, which is slightly larger than the expected gain of 100K. Although the most significant headline was the 4K decline previously reported for August, which had caused so much angst was revised sharply higher to an increase of 89K.

General speaking, the non-farm payrolls report is the most market moving indicator for the US Dollar. Yet despite sharp intraday volatility, the Dollar ended the US trading session not far from where it hovered prior to the payrolls release. In fact, the Dollar’s refusal to go down in a face of a “goldilocks” employment report indicated that traders believe that the payrolls number had significantly reduced the chance that the Federal Reserve will continue lowering interest rates. And this is bullish for the Dollar.

The US Dollar Index (daily) chart above addresses a short-term time frame. The Relative Strength Indicator (RSI) had printed a positive divergence on the daily chart around the area of the long-term support. Technically speaking, the short-term picture is bullish as long as the index holds above the 77 level.

“OK, it’s good to know but does it have anything to do with stocks?” You might be wondering. Well, as a matter of fact, the Dollar has been an important proxy for equity market, especially the blue-chips (transnational corporation) stocks, since 2003.

As you can see from the chart above, the US dollar was highly correlated to the blue-chip index from mid nineties to early 2003. There were a lot of explanations to the 2003 “separation” though it’s beyond the scope of this newsletter to go into details. All you have to know is this: since early 2003 almost every blue chip’s new peak is accompanied by a new low in the US Dollar. This is true until last week.

The Dow Jones Industrial Average (daily) chart above addresses a short-term time frame. The blue-chip index printed a fresh record high last Friday around 3 PM (ET) though the last 30 minutes sell-off had caused the index to close roughly 30 points below the life time high recorded on October 1, 2007. This [last minute sell-off] indicated that traders were hesitated to pay up for stocks due to the fact that the blue-chips’ high new didn’t confirm by the Dollar (see the US Dollar Index chart above). This technical non-confirmation suggested that the blue-chips index is at or very close to a meaningful peak. A decline to below 13700 will confirm this.

In summary, the short-term non-confirmation (between the blue-chips Index and US Dollar Index) might not result in any real long-term technical damage for the blue-chips though it suggested that the Dollar might have reached a short-term tradable low. Further, we believe that the intermediate-term picture [for the US Dollar] will become more bullish as long as the indicators retain the current positive states. Consistent with these thoughts, while we were pretty aggressive on stocks at the mid-August lows, we are now more cautious.

Until next time, good luck!

(By: Michelle Mai for Capital Essence)

Note: Michelle Mai writes technical analysis for Capital Essence and is the editor of Capital Essence’s “Market Outlook” newsletter. To receive the daily edition, please subscribe. It’s now available at a monthly rate.