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Top Dollar?

12/03/01 08:49:52 AM
by David Penn

As the greenback retreats from highs not seen since the mid-eighties, should stock investors be concerned?

Security:   DXY
Position:   N/A

The rise of the U.S. dollar in the second half of the nineties was considered by many to be one of the signature characteristics of the great secular bull market from 1982-2000. Indeed, many consider it now a truism that a rising dollar is bullish for both stocks and bonds. However, as John J. Murphy points out in his seminal study, Intermarket Technical Analysis, there is more to this relationship than meets the eye. Using the first leg of the 1982-2000 secular bull market--the leg from 1982 to 1987--Murphy shows how not only a rising greenback, but also falling commodities prices, are necessary for stock and bond traders to get the signal they need that a new bull move may soon be underway.

Taking a look at what the greenback may be able to reveal about the near-term future of the stock and bond markets may be especially helpful now, as a post-September 11th war rally has encouraged many investors and traders to believe that a new bull market has been born. Moreover, other bulls point to the massive amounts of liquidity provided by the Federal Reserve Board's interest rate cutting campaign, or perhaps the mountains of money that have piled up in money market funds--money stock market bulls are convinced will find its way eventually into the stock market.

Tops in commodities combined with bottoms in the greenback precede bullish turnarounds for equities.
Graphic provided by: MetaStock.
However, the present action between the greenback and the commodities market--commodities being the key ingredient in the forecasting ability of the relationship between the dollar and stocks and bonds--suggests that the war rally may have run its course. Intermarket analysis suggests that bull markets in stocks generally come about after the greenback has bottomed and commodities--for example, as measured by the CRB Index--have topped. The opposite is also strongly suggested: that bear markets tend to occur when the dollar tops and commodities, after a period of correction, begin to rally.

This may be common sense in the abstract. While a rising dollar is often bullish for stocks and bonds, it is the added element of falling commodities prices that truly makes the bullish environment for equities. This particular scenario was played out in 1995 as the dollar finally ended its 10-year swoon from a peak of 165 (as measured by the U.S. Dollar Index), and the commodities market (again, by way of the CRB) reached an intermediate term peak later in that same year. As the chart shows, equities took off in 1996, resuming the bull market advance that had begun in the early 1980s--the previous time when a major top in commodities occurred more or less simultaneously with a major bottom in the greenback.

The current context, in which the U.S. dollar appears to be making a major intermediate top at the same time the CRB looks to have bottomed on an intermediate basis, hints at an outcome opposite that of 1996. Here, a falling dollar accompanied by rising commodities prices is more likely to bring about a bearish environment for stocks and bonds. A historical example of this pattern occurred in 1986, as an intermediate bottom in commodities coincided with a greenback that had peaked in 1985. What followed was a bond market crash in April 1987, a stock market crash in October 1987, and--just after the market recouped its losses--a recession in 1990.

The greenback has benefited from safe haven status in the face of global economic vulnerability and the war effort in Afghanistan, which helps explain the dollar's resilience in the face of a major interest rate cutting program initiated by the Federal Reserve (falling interest rates led to weaker greenbacks). However, if the liquidity infusions of 2001 finally start to yield results in 2002, the consequences--a weaker greenback, higher commodities prices--could conceivably buttress the economy at the stock market's (short-term) expense.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine,, and Advantage.

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Comments or Questions? Article Usefulness
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Date: 12/04/01Rank: 5Comment: Very interesting...I had not previously thought of looking at the intermarket analysis of DX, CRB and S P...I will start watching it...
Date: 12/10/01Rank: 4Comment: 
Date: 12/12/01Rank: 5Comment: thanks

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