The Dow has been trending lower since July 22, 2011. Other than a fabulous 600-point rally from 3PM to 4PM following the Fed meeting of August 9, 2011, the trend downward has been brutal and abrupt. There was also a 400-point rally two days later that was followed with two more rally days on falling volume. That may have been a warning sign. The Dow then turned lower oddly enough at just about the 38% Fibonacci retracement line of the descent. The Dow now sits at 10817. What will happen when the markets open on Monday?
Of course, no one knows for sure but there is a very interesting chart that might give us some insight. The chart below is a picture of the FXE (the euro) in gold and the USD (the dollar) in green over the past 8 years. Why should we pay such close attention to currency right now? Clearly over the last few years especially, the Dow has risen with a declining dollar and fallen with a strengthening dollar. The Dow is now lost in a current of inflation. If this relationship continues, the currency charts might be our best reference for equity trends. We must respect three messages from the chart.
One, the dollar and the euro have been undulating over the term. They grow apart. They close back together. Right now, the two lines are far apart. History would indicate the two lines must move back together. The euro must weaken and the dollar must strengthen.
Two, notice the point labelled ‘A’. The blue line is the intersection of the FXE and the USD. For both currencies to close back together and touch, the euro needs to lose about 10% and the dollar must gain about 10%.
Three, notice the point labelled ‘B’. The euro looks to be in a bearish formation known as a descending triangle. This could be interpreted as a bullish pennant but pennants should only extend for a period of less than 8 weeks. This formation is now more than 3 months in duration (the chart is period weekly). Descending triangles are nasty bearish patterns. When the pattern is broken below the lower horizontal line, the down trend accelerates.
FXE in gold, USD in green - 8 years weekly ending 8/19/2011
Chart courtesy StockCharts.com
All three points taken together are strong evidence that the dollar and the euro lines are going to move back together. This should happen over the coming weeks. This is a near-term signal only as we should expect the two lines to come together and then spread apart again. Investors should be aware that a 10% appreciation in the dollar would not be a positive development for the Dow. We should also be aware that currency valuations are heavily guarded and manipulated by issuing authorities.
If the US dollar rallies, we should expect:
- Stocks to fall
- Oil and metals to fall
- US Treasuries to rise
We shall see if the impending doom of a descending triangle plays out.
Disclaimer: The views discussed in this article are solely the opinion of the writer and have been presented for educational purposes. They are not meant to serve as individual investment advice and should not be taken as such. This is not a solicitation to buy or sell anything. Readers should consult their registered financial representative to determine the suitability of any investment strategies undertaken or implemented. BMF Investments, Inc. assumes no liability nor credit for any actions taken based on this article. Advisory services offered through BMF Investments, Inc.