For All Dollar Chartists: An Outlook For 2010
Now that the market lives and breathes with every Fed decision and transaction, reading tea leaves and juggling cow feces has about the same predictive impact on security outcomes as analyzing fundamentals or technicals. Yet from the perspective of correlations, nothing is as important as the dollar: equities have a -100% correlation to the value of the dollar, which in turn impacts commodities and even interest rates. The dollar is the primary market leading indicator. Which is why we present the key points from the Goldman Sachs "Themes and Ideas for Q1 2010 and Beyond: FX Sales Strats" in which Goldman shares a few thoughts on why in its chartist opinion, and contrary to that voiced by Jim O'Neill and other Goldman strategists, the dollar is headed higher. And possibly much higher.
On why the upside in EUR is limited:
Various resistance levels have been reached- 76.4 retrace of 2008 fall at recent highs:
Another 76.4 retrace: AUDUSD whose October low was 0.6007, relative to retrace level of 0.5971.
The 55 DMA in the EURUSD has been breached. Next stop: 200 DMA at 1.4118
This compares to an inverse breakout in last 2008.
And if we get a 200 DMA correction, then what?
Some observations here:
- The '92-’95 comparison again gives us some useful input. Following the initial peak at 1.3837 in April ’95, where the market had recovered approximately 80% of the September ‘92-August ’93 sell off, it begins to form a topping structure, but it’s a drawn out multi-month process.
- Looking at the zoomed chart on the right and tracking the colour coding; following the rally to 1.3837, EURUSD sells off sharply breaking below the 55-dma for the first time in a number of months and nearly closes the gap to the 200-dma, it then recovers to make a marginal new high for the cycle around 3-months later, from there a broader down move starts and that level is not seen again for nearly 12-years.
Most notably, the dollar is massively overvalued when compared to the GS Dynamic Equilibrium Exchange Rate Model. According to this the EURUSD should be at $1.20
- EURUSD very seldom moves significantly above/below 2 standard deviations from fair value.
- The chart opposite shows EURUSD spot in blue, and GS Research’s GSDEER (Goldman Sachs Dynamic Equilibrium Exchange Rate Model) fair value estimate for EURUSD in Red. This is then overlaid with a two standard deviation range around the fair value estimate in green.
- As can be seen, EURUSD very seldom moves more than 2 standard deviations away from fair value, and has never sustained such a move for an extended period when it has happened. The market tending to subsequently reverse sharply back towards fair
- Again looking back to the ’92/’95 period with which we’ve made a number of comparisons, the market moved more than 2 standard deviations above fair value as it peaked in ‘95. It them consolidated at that extreme and eventually turned back toward fair value. This is another similarity between the price action from July ‘08 to now and from September ‘92 to April/August ‘95.
Goldman's chartists' summary view: an initial move close to the 200-dma, followed by a recovery toward the highs and then another larger down move
- The colour scheme used on the chart opposite is the same as that used for the historic comparison chart on slide 5.
- In brief it appears that the market may well be entering a drawn out, i.e. lengthy, topping process.
- Using the colour scheme opposite: Following the trend into the cycle highs the market completes a correction to the 200-dma which stands at 1.4118 – similar in inverse to the move from December ‘08. It then bounces from the 200-dma, similar to last December and also very similar to the price action seen at the ’95 highs – the comparison with ‘95 implying the risk of a double top (marginal new high beyond 1.5145). From here the market may well set a significant peak and prepare to decline on a trend basis.
- The charts on the following slide highlight why it seems reasonable to expect the topping process to be drawn out and also what we’re watching for signals of a more immediate turn taking place.
Is any of this relevant? Who knows - the Fed's intervention sure makes for pretty charts. The question is at what point will the Fed vigilantes take matters into their own hands. So far they have run from any head on confrontation, which is explainable seeing who is armed with a dollar printing press. So look to Europe, and things there are turning ugly quick. Should the dollar retrace to 1.36 on the EUR, the carry trade will collapse and look for a major retracement in stock market gains. The only question is how soon? Only Bernanke knows the answer.