Dow Jones Fails at Resistance

The Dow Jones Industrial Average (DJIA) recently tested then failed at resistance (of 11,258). There were signs in advance that this might happen. First, the index was very overbought, as the RSI (for nine periods) was far above the typical overbought reading of 70. Second, there was an intermarket relationship at work -- the US dollar found support. For quite some time now, the stock market and the US dollar have moved in opposite directions (the result of the dollar carry trade). The chart below (click to enlarge) shows this recent price action in the DJIA. The line below the DJIA chart is that of the US Dollar Index. Note how it turned up at support just as the DJIA failed at resistance.

Where will the market go from here? Translating this to technical analysis, where is the next support level? From the chart, the next support occurs at 11,100. The second (next) support level after that is at 10,900.

There is another element in this situation that needs to be examined, however. While the overall market has recently pulled back, does this mean the uptrend has now ended? The definition of an uptrend is not, as might sometimes be thought, continual increases in price. Instead, an uptrend is a series of higher highs and higher lows in price. At present, the DJIA is still in an uptrend. There is another way to help determine this. Using the RSI, an uptrend exists as long as RSI(9) > 40. While typically, a bullish signal is an RSI at or above 50, many persons (including myself) use support for a trend at the RSI of 40. In other words, as long as the RSI(9) remains at or above 40, view the uptrend in the DJIA will still be in tact.

So, will the uptrend remain in tact? Remember that in general, stock prices depend on interest rates and profit expectations. The primary driver at present is profit expectations. So, the question shifts to how profit expectations will behave in the near term. To answer this, it is necessary to consider monetary policy and QE2, whether US fiscal policy will shift to being contractionary, what other central banks are doing and will do, and how much strength other economies will be able to sustain. A critical factor in this is the strength of the Chinese economy. This is obviously related to whether China will further tighten its credit. A possible slowing of Chinese growth was behind today's (Friday) pullback.

To end this post, look at profits, the difference between revenues and costs. As the US dollar has been weakening, which has pushed commodity prices higher, this will raise production costs, working against future profits. What about revenues? If the economy begins to grow more rapidly and consumer spending continues to strengthen, then revenues may well continue to move in the right direction. But will this be enough to offset the effects of commodity-based cost increases? This is the question that everyone will be attempting to answer in the coming weeks.

November Employment Report

The November employment brought with it several surprises. First, and foremost, payroll employment fell by far less than just about anyone (including me) had predicted. While the consensus number was a decline of around 120,000, the actual number was a decline of just 11,000. In addition to this, decreases from the prior two months were revised to show less job loss. So, with the addition of Census workers early next year, it is very likely that we will see the employment change go positive -- either next month when the November data are revised or when we get January or February data.  Second, there was a nostalgic element to Friday's action in that the stock market actually rose along with the US dollar. When was the last time that happened? You should read about the employment report from MarketWatch.com and the Wall Street Journal.

The stock market liked the employment report very much. The Dow-Jones Average started out showing a gain of around 150, but as is so typical of employment release days, gave most of that back (this apparently works in both directions). At the end of the day, the Dow was up 23 points (for 0.2%). Interestingly, the NASDAQ was up by a greater percentage than the Dow, as its 21 point gain was almost 1 percent. Typically, when observing markets it is a good sign when the NASDAQ outperforms the Dow-Jones average. As this stock market "rally" was occurring, the bond market obviously hated what it saw, so a selloff resulted. As bond prices fell, the 10-year bond rate rose by a full 10 bp, a rather significant change. The US Dollar index rose by just over one point (1.07) to close at 75.8. So, enjoy this combination while you can -- a bullish report triggered stock market gains, a bond market sell off, a stronger US Dollar, and a drop in Gold price. That is the way things normally go, but haven't gone this semester as the result of the dollar carry trade.

Along with this favorable economic report, of course, comes all the myopic garbage that has come to characterize coverage by the financial media. Will the Fed now begin to raise rates very soon based on the new-found economic strength? Give me a break! Is the carry trade dead, based on Friday? Gee, we have one full day of that result, so it must be inevitable! I'll probably reserve judgment, though, until I hear from Jon and Kate, and check in with Tiger Woods. Here is the URL for an article with an intelligent discussion of the likelihood of Fed actions based on Friday's report.

The interesting question is how long the pattern of the inverse relationship between the dollar and US stock market has existed. It must seem to all of you that this has been around for a very long time, that this is the "norm." For extra credit due at the beginning of class on Tuesday, produce a chart using weekly data going back three years with the Dow-Jones average and the US Dollar index in the same chart, both as solid lines. Adding annotations, eliminating other elements of the graph like MA's, pinpoint when the current pattern began based on this chart.

So the question now becomes whether the dollar carry trade is dead or possibly dormant for a while. If this is conjecture turns out to be true, the US Dollar should begin to rally without threatening the positive momentum of the US stock market. We can use technical analysis along with economic theory to ascertain whether any short-term bottoming of the dollar is in the cards. Based on the RSI(9) from weekly data, there was a bullish divergence for $USD -- the RSI had been rising while the weekly $USD was recently falling. So, in the very short-term at least, some dollar strength is likely, especially since the RSI is nowhere near an overbought level. In fact, the weekly RSI(9) is at 40.5, which if you look back several months to April, is a resistance level for the RSI. If that resistance is broken, the dollar index could go to either 77 (its next resistance point  determined the usual way) or all the way to 80 based on a Fibbonnacci Retracement from March of 2009 until the most recent low. Stay tuned!

Friday's Tumble

The stock market tumbled on Friday. The ultimate decline, 312 points, was a blessing. How? Before trading began here, markets in Asia and Europe had fallen sharply. Stock index futures for the Dow-Jones, S&P, and NASDAQ all had trading halted, as they reached limit down. Those futures were signaling an open in the US with the Dow-Jones falling as much as 1,000 points! Prior to opening, the word "crash" was being used by many (almost all, actually) market observers. I also viewed the potential for labeling the entire bear market as a crash had expectations occurred.

While the markets did drop sharply at the open, they began to recover. At times during the day, the market had moved to only "small" declines in the context of what has been happening routinely now for weeks.


The chart (click to enlarge) shows technical information about Friday, using 10-minute bars. The first thing to note is where support and resistance were. Resistance from late Thursday held all through Friday, not a very bullish sign, even though the market didn't end up at its daily low (there was a failed breakout at the end of Thursday). Look at the last bar of the day: a large bar (big range in last 10 minutes), but the close was far below the open for that time interval, also bearish going into Monday.

It is also important to consider that support held on Friday, making the overall news mixed. There was a double bottom, a reversal pattern, which signaled the rally that started around 2:00. During that time, the RSI remained above 50, signaling that an uptrend was occurring. That only changed at the close.

What were the economic factors surrounding Friday? First, there were large sell-offs in Asia and Europe. GDP for England was negative for the first time in about 15 years. That became a confirmation signal to markets that a global recession was either already in progress, or very likely. In the US, home sales actually improved. Of course, whether this is the beginning of a sustainable uptrend is a different matter. That accounted for part of the upward momentum at mid-day. Finally, one of the more important factors was the collapse of the yen carry trade. Review this on the online notes and don't be surprised if it pops up on the exam this Tuesday. For an excellent video clip concerning this, click here. As investors cashed in their overseas investments, they paid their yen loans, since the primary risk from the carry trade is the yen appreciating relative to the US $. Clearly, that had been happening all week. As I write this, the dollar-yen exchange rate is below 95 yen/$.

To determine how markets will do this week, check out the week's economic schedule. On Thursday, we get the first read on third quarter GDP in the US. IF, as many of us suspect, this will come in negative or very small, the global recession scenario will be reinforced, causing heightened market weakness, in spite of whatever market momentum might occur on Monday through Wednesday. Stay tuned!