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In The US Dollar And The DJIA, Which Leads?

11/02/09 09:49:08 AM
by Koos van der Merwe

Much has been said that the Dow Jones Industrial Average moves contrary to the movement of the US dollar. Is that true?

Security:   DWIX, UDX, VIX
Position:   Hold

When we listen to the various business programs on TV, the discussion usually centers on how the Dow Jones Industrial Average (DJIA) is moving contrary to the value of US dollar. When the dollar is weak, the DJIA strengthens, and vice versa. Is this truly the case, and if so, why? Then of course there is the CBOE Volatility Index (VIX). How does that relate to the movement of the DJIA?

Graphic provided by: MetaStock.
Figure 1 is a chart showing the DJIA, the US Dollar Index, and the VIX. Note the following:

A. The US Dollar Index started falling, and the DJIA started rising.
B. The US Dollar Index started rising and at first the DJIA start rising with it.
C. Then the DJIA gave up its independence and started falling while the US dollar continued strengthening. The question is what influenced the DJIA to allow it to move independently of the US dollar. I can only assume good economic data was announced, but the DJIA soon gave way.
D. The US dollar started falling, and the DJIA started rising as expected.
E. Once again the US dollar started strengthening and the DJIA strengthened along with it.
F. However at F, the US dollar started weakening once again and the DJIA continued stronger.
G. At this point the DJIA continued to strengthen, and the US dollar started strengthening.
H. From this point, the DJIA started weakening, and the US dollar weakened along with it, till ...
I. The two correlated inversely almost perfectly.

Looking at the VIX , we see only one trend signal. At point A when the VIX was above 80, it did signal that the DJIA would strengthen, and after than it is only now, with the VIX at 22.5, that it suggests that the DJIA should start weakening for the short to medium term. This therefore suggests that the US dollar will strengthen, so the question we ask is what is leading what. Is the US dollar leading the movement of the DJIA, or is the movement of the DJIA influencing the movement of the US dollar?

Fundamentally, a weak US dollar is good for the US economy, and as long as inflation is low, it pays the US to have a weak dollar, simply because US-manufactured goods are more competitive in the world markets. Too many traders are focused on the US dollar for the movement of the markets. When good fundamental data comes through, the DJIA dissociates itself from the movement of the US dollar. As long as inflation is low, interest rates will be low, and the US dollar weak. The market always anticipates, and the DJIA being the market will therefore always lead.

Koos van der Merwe

Has been a technical analyst since 1969, and has worked as a futures and options trader with First Financial Futures in Johannesburg, South Africa.

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