Clouds Gather, but Dollar Remains Key for Now

Movement in the greenback will largely determine the near-to-medium-term outcome for stocks

Editor’s note: Beat the Bell editor Serge Berger will be filling in for Sam Collins until May 26.

The story for 2015 thus far has largely revolved around the movement in the U.S. dollar and global interest rates. As such, it shouldn’t be surprising that the most recent downward acceleration in the dollar has brought about new opportunities in the markets.

This year has been much more macroeconomic focused than previous years, and most of the better directional moves occurred in places other than U.S. equities, such as interest rates, commodities and currencies, as well as European and Asian equities.

The past few weeks of trading in the S&P 500 have been lackluster at best, and some trading desks I spoke with this week mumbled phrases like “early summer doldrums.” But market participants with real skin in the game are watching more than just the S&P 500, and there are some important things to take notice of.

S&P 500 Chart
Click to Enlarge

First, the S&P 500’s multi-month sideways slither has, to no great surprise, also tightened the Bollinger Bands. The longer Bollinger Bands are close together, i.e., the longer the index goes sideways, the sooner we are likely to see a meaningful directional move and/or increased volatility.

As I highlighted in the previous Daily Market Outlook, a break above the 2,120 level in the S&P 500 on a daily closing basis should clear the way for a move to 2,150, the next upside target. Traders looking to play this may want to consider doing so with smaller position sizes due to the bigger imbalances overhanging the market.

DIA vs IYT Chart
Click to Enlarge

On the Dow indices, something peculiar is happening. On the chart above, I plotted the SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA) at the top and the iShares Dow Jones Transport. Avg. (ETF) (NYSEARCA:IYT) at the bottom.

While the industrials are trying to break to fresh all-time highs, the transports are threatening to break below a key support line. As someone pointed out to me, this is the first time in 100 years that the industrials are at a 52-week high while the transports are near a six-month low. In other words, there is a notable negative divergence flashing here. And for those taking clues from Dow Theory, which labels the transports as a leading indicator, this is one more warning sign for stocks, at least through a multi-month lens.

In the bigger picture, however, much of the near-to-medium-term direction for U.S. equities depends on the movement in the dollar, which in turn, is influenced by investor perception of the Federal Reserve’s monetary policy.

On Thursday, I showed a chart of the relative weakness of the iShares Russell 2000 Index (ETF) (NYSEARCA:IWM) versus the SPDR S&P 500 ETF Trust (NYSEARCA:SPY), another early indicator that stocks may be beginning to top out.

IWM vs UUP Chart
Click to Enlarge

Today, I want to look at the Russell 2000, via IWM plotted at the top, to get a better idea of its sensitivity to the movement in the dollar, via PowerShares DB US Dollar Index Bullish (NYSEARCA:UUP) at the bottom.

Just as the rising dollar was good for small-cap stocks in the first few months of the year, the now slumping dollar is hurting those stocks. This is because Russell 2000 components derive the majority of their sales from the United States, so their revenues are less dollar-sensitive.

On the other hand, dollar weakness is a direct tax on the U.S. consumer by way of reduced purchasing power, and that’s at least a good part of the reason for the recent relative weakness in small caps versus large caps. UUP topped out in mid-March, and that eventually caught up with IWM in mid-April.

Conclusion

While the moves in the dollar and interest rates will determine the near-to-medium-term outcome for stocks, clouds are gathering on the horizon. However, in the time frame of the next few days to few weeks, the S&P 500 still looks primed to work its way toward the 2,150 area and possibly marginally above it.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/05/daily-market-outlook-clouds-gather-but-dollar-remains-key-for-now/.

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