Friday, October 09, 2009

Another Look At The Dollar And The Stock Market Rally

I'm really backed up on my posting schedule of items I planned to get up in the second half of the year. Too many other good topics and not enough time. I'll get them all up at some point but today let's take another unique gander at the dollar. I'll get one more post up on the dollar sometime very soon but let's throw a teaser up for today.

First, I'll say if you want to understand this market, you need to think like a trader because as we have stated a dozen times over the years, this market is dominated by traders. If you are investor (which I much prefer to be but am smart enough to know has and will continue to be a fool's game for some time) you are bound to get fleeced at some point. Just as has happened numerous times in the last decade.

Below is a chart of the dollar ETF from Rydex that trades in the U.S. In blue is the associated daily volume and in red is a long term average of daily volume. I didn't realize I left the scale off the chart until printing it but volume over the last month or so is up 8-10 times over the prior months. I'd say an 800% increase in volume on a relatively sustained basis is more than a few deviations from normal. During that period of time the dollar has made marginal new lows but the stock market has essentially made no gains.

In fact, while the averages have remained flat, the underlying tone of the market has weakened considerably. No one knows if this will last or is temporary but proof of this is the second or lower chart of the S&P. Overlaid on this chart are the buy and hold/sell signals of a trading algorithm I often use. We can see that the algorithm has been out of the market for the past month. Noticeably, the algorithm has not responded with a new buy signal even though we are back to testing old highs. This compares unfavorably to the prior minor correction during the last days of August and beginning of September where said algorithm issued an immediate buy signal after a short period of market weakness.

So, what might all of this tell us? Well, what did we say in our post last week? The masters of the universe, the fathers of Frankenstein finance were levering up on dollars to buy risky assets. So looking at the dollar ETF, could it be that every blooming idiot is now completely sure the dollar is going lower and as a result has sold the dollar ETF short in large quantities over the last month hence the enormous spike in ETF volume? And then used this trade as a vehicle to fund new long positions in risky assets?

Is everyone nearly "all in" on the stock market rally? And using leveraged positions in the dollar as their financing vehicle of choice? Just something to think about. You might also think about what a stronger dollar might do to this V-shaped recovery rally. Or not even a stronger dollar but a dollar that refuses to continue its downward trek. Booyah!

posted by TimingLogic at 10:53 AM