Hodgepodge – US Dollar Index & Dow Theory Non-Confirmation

Quotable

“Our knowledge can only be finite, while our ignorance must necessarily be infinite.”

Karl Popper

Commentary & Analysis
Hodgepodge – US Dollar Index & Dow Theory Non-Confirmation

US Dollar Index – Two Views

Some of the best pieces of advice traders can find come from an unlikely place—poetry. In these two lines from T.S. Eliot’s brilliant poem, “Ash Wednesday,” he effectively summarizes two key tenets needed to be successful in trading:

Teach us to care and not to care

Teach us to sit still.

Put another way, this means to me: 1) trade your edge and only that; don’t get all wrapped up in being “right;” don’t believe too much in your own story because Nemeses—the spirit of divine retribution against those who succumb to hubris—will soon be paying you a visit; and 2) know your time frame; a good idea based on a multi-week view can be a very bad idea if you trade it using hourly time frames for levels.

When it comes to playing the direction of the US dollar over the past few weeks, I have been able to make both mistakes in a big way proven again that knowing and doing are two very different things. So, let’s take a fresh look at the dollar index and consider two scenarios.

The US dollar, based on the US dollar index, has been in a range for last 13 months. I have been working off the view we are simply in a correction lower with another bull market leg due to take the US dollar index to new cycle highs. But as much as I do expect yet another leg up in the dollar, there is another plausible scenario.

Scenario #1: Correcting in Wave 4 as seen in the chart below:

Key points supporting the correction scenario:

  • Yield matters. Despite the fact the US dollar has fallen about 6.5% from its high back in Feb 2016, the yield spread (measured here by the difference between the 2-yr benchmark United States versus Eurozone) will matter. Despite relative tepidness of the Fed Reserve Bank, it is the only major central bank likely to raise interest rates during 2016, suggesting the relative yield will go even higher in favor of the US dollar. Thus, we should expect the dollar to rally once again in Wave 5, i.e. this bull market isn’t over. Correction support areas come in at 92.20 (38% retracement of Wave 3); then 89.60 (50%) retracement of Wave 3. [Alternative bull resumption view: The dollar gets a major risk bid on another credit crunch like crisis selloff in global stock markets.]

Scenario #2: The dollar bull market is over—the top is in place.

Key points supporting the dollar bull market over view:

  • Yield matters and the dollar will lose the relative yield support which sustained the bull market rally to date. Why? Because the US Fed will soon signal it will not hike rates during 2016; plus indicate the FOMC is seriously considering following down the monetary path blazed by Europe and Japan into negative rate territory. This in turn will intensify the now budding recovery in commodities and the US dollar will play the mirror image roll again, i.e. commodities up and dollar down, as was the case during those pre-credit crunch “boom” years.

I am still in the dollar bull market to resume camp. But I am no longer in love with the story.

Dow Theory Non-Confirmation

I shared this with our Key Market Strategist (KMS) subscribers yesterday. We changed our view on stocks Monday at the close and told our KMS subscribers to get short. So far so good.

Dow Theory Non-Confirmation Weekly View: According to Dow Theory, any new swing high or swing low in one index, must be confirmed by similar price action in the other index. I am no Dow Theory expert, to say the least, but the chart below appears to be a non-confirmation signal. The Dow Jones Industrial Average made a fresh swing high (black line), but it was not confirmed by a similar new swing high in the Transports (red line). It suggests a deeper move lower could be in the cards, beyond a standard correction to the bull trend.