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Have We Reached a Dollar Bottom?

After its slump vs. other currencies, the buck may be nearing important chart support. Plus: The latest signals for stocks and oil

From Standard & Poor's Equity ResearchThe S&P 500 broke out to a new recovery high last week, while the Dow Jones industrials, Dow Jones transports, Dow Jones utilities, S&P Small Cap 600, and S&P Mid Cap 400 all broke to fresh all-time highs. For the "500," the slope of the rally since mid-March remains fairly steep, and if it continues, we will get the upside blowoff that we have been talking about. Meanwhile, the charts are signaling that the U.S. dollar may be tracing out an intermediate-term bottom, while crude oil finds itself in a mildly bullish scenario.

Stocks: Since the secondary low on Mar. 13, the S&P 500 has rallied almost 8% in 27 trade days. That is the best performance in a 27-day period since December, 2004, and comes during a period where worries over earnings growth, economic growth, housing, crude oil prices, and China, to mention a few, were elevated. We believe until these worries dissipate, and more investors embrace the rally with both hands, that an intermediate-term or long-term top is not in sight. Market tops are defined by euphoria, and we just do not see that type of emotion at this point.

What we find both bullish and bearish about the current price structure of the S&P 500 is its slope or angle of ascent. Let us explain. A steep upside slope is great as gains come very quickly, but they are not sustainable for a long period of time. Sometimes, but not always, they can lead to swift moves to the downside as there is little chart support on the way down. The type of upside blowoff we have mentioned recently is not the type that the Nasdaq traced out in the late 1990s. It is more of a short-term phenomenon that may take place over a month or two. We will review some of our work from an earlier comment and see how we are progressing.

One of the main points we made in that comment was that there seemed to be different phases of a bull market, and these different stages could be defined by the slope of the advance over the intermediate term. At the start of many bull markets, the slope is very steep. For instance, from March, 2003, until March, 2005, the angle of ascent was fairly steep. Then, from March, 2004, until July, 2006, there was a decrease in the rate of advance. However, since the intermediate-term bottom last summer, the slope of the bull market has reaccelerated twice with the uptrend steepening after the mid-March low.

There are a couple of examples of mini-blowoffs that we can look at to potentially get some perspective about how fast the market can rise and how it compares to the jump we have witnessed so far. Two mini upside spikes occurred in the year after the 4-year cycle low, which we are in now. In addition, they both happened after a mini shakeout that occurred after a low volatility advance.

The first instance was in 1995/1996 when the S&P 500 jumped 10.5% in 23 trade days. The second happened in late 2003/early 2004 when the "500" surged 12% in 55 trade days. If we simply average these two occurrences, it would equate to an 11.25% rally. Applying this to the Mar. 13 low of 1377.95 would target the 1533 level, just points above the all-time high of 1527.46.

This is certainly an unscientific way to arrive at a target, but we have said in the past that the market does have a tendency to have problems when it first reaches an important high from the past, so it would certainly not surprise us (assuming the rally continues) for the market to pull back or correct after reaching the old highs.

Another example, which could be categorized as a major market blowoff and that has a fair amount of similarities based on both price action as well as cyclical analysis, was in 1987. This time period, as well as the chart pattern from back then, matches up pretty good with today's action. 1986 was a 4-year cycle low in which we did not have a bear market, just like 2006. The bull market was in its fifth year, just like today. In early 1987, the S&P 500 exploded 24.5% in less than three months.

This is certainly a larger gain than the present advance we had off the summer 2006 lows, and much quicker. The index then went through a fairly quick shakeout, falling 7.5% in six trade days. This is somewhat similar to what we went through in late February/early March. The market then put in a double bottom, broke out, and then retested the lows. The "500" then had an upside explosion, running 21% in 67 days right into the 1987 top.

With the S&P 500 at its highest level since September, 2000, we think there is very little overhead chart resistance to be concerned with. The next piece of potential resistance comes from a trendline drawn off the highs since October, 2006, and this comes in at 1509 at the end of April. The second piece of potential resistance is Fibonacci in nature and is based on the width of the latest pullback. This initial Fibo target lies just shy of the all-time at 1521.88.

In the very near-term, perhaps over the next week, we do see the potential for a shallow pullback. The S&P 500 has risen six out of the last seven days and twelve out of the last 14 days and is very overbought on a very short-term basis.

The dollar: The U.S. Dollar index is approaching major long-term chart support near 80, and we think the greenback may be tracing out an important intermediate-term bottom. The Dollar index is computed using a trade-weighted geometric average of six currencies and their trade weights are 57.6% for the Euro, 13.6% for the Japanese yen, 11.9% for the British pound, 9.1% for the Canadian dollar, 4.2% for the Swedish krona and 3.6% for the Swiss franc.

Since the beginning of 2004, the U.S. Dollar index has been in a base between 80 and 92. This base follows a bear market that started in early 2002 from up at the 120 level. Since November, 2005, the Dollar index has been in a downtrend, making a series of lower lows and lower highs, all within the confines of the large base.

With the index currently at 81.60 area, we are very close to the initial bear market low of 80.58 from back on December 30, 2004. The low in 2004 also corresponds with the major low from way back in 1995 that was also in the 80 zone. Because this level has held for so long, it is considered critical chart support from a long-term perspective. In addition to chart support, the index is approaching trendline support off the lows since May, 2006. This line of potential support sits at 81.30. So to say the least, it appears the currency is right on top of major support.

Since early 2006, the Dollar index has been tracing out a potentially bullish wedge formation. This pattern is made up of a steep trendline off the recent highs and a somewhat flattish trendline drawn off the recent lows. To complete this formation, the index would have to reverse to the upside and take out the trendline off the recent highs up in the 83 to 84 zone. Daily and weekly momentum indicators are oversold, and there are some bullish divergences on the daily momentum charts.

In addition, it appears that the futures market is betting on an upside reversal in the U.S. dollar and a downside reversal in the Euro. The strength of the Euro has been the primary driver of the weakness in the U.S. dollar. The Commitment of Traders report is showing that the commercial hedgers (smart money) are net long the dollar and net short the Euro, while the large speculators (dumb money) are net short the dollar and net long the Euro. While the street consensus is for further dollar weakness, the charts and the futures market are setting up for some strength.

Oil: Crude oil futures are trading in the $63 to $64 per barrel range after pulling back to trendline support. There are multiple pieces of resistance that start near the recent highs of $67. While we think the chart pattern looks bullish, sentiment towards crude oil does not suggest a big break to the upside. Commercial hedgers (smart money) have their largest net short position since last August, while large speculators (dumb money) have their largest net long position since last August. With this setup in the futures market, we think things may get interesting in the oil pits.

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