Guest Post: The Stock Market And The Dollar: There Are Only Three Possibilities

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

The Stock Market and the Dollar: There Are Only Three Possibilities

With stocks and the dollar on a see-saw, there are only three possibilities to choose from.

Since the stock market is in the news (perhaps as a result of trillions of dollars/euros/yen/yuan/quatloos having suddenly vanished from millions of accounts), it seems timely to examine the key correlation between stocks and the U.S. dollar. As I have often noted here, this "big picture" correlation is a simple see-saw: when the dollar is scraping bottom, stocks are at their highs, and when the dollar is up then stocks are tanking.

At the risk of alienating chart-averse readers, I've marked up the charts of the S&P 500 (SPX) and the U.S. dollar index (DXY).

For those who aren't going to look at the charts, what they suggest is that there are really only three possibilities in play:

A. Stocks go up and the dollar drops to new lows

B. Stocks fall and the dollar rises significantly, a pattern that has repeated several times since 2007

C. The see-saw breaks and stocks and the USD rise or fall together.

The key to the relationship between stock valuations and the dollar is corporate profits. When the dollar declines, then U.S. global corporations' overseas earnings--now roughly 60% of total profits for many big global corporations--expand as if by magic when stated in dollars.

When the euro and the dollar were equal back in the early 2000s, then 100 euros of profit was $100 when stated in dollars. When the euro rose to $1.60, then the same 100 euros of profit earned by the U.S. corporation in Europe became a stupendous $160 in profit when stated in dollars.

This explains why the Fed has been so keen to trash the dollar: it magically increases corporate profits and thus drives stocks higher. The mainstream financial media's explanation for the weak-dollar policy is that the Fed is anxious to increase exports, but this is a sideshow; exports make up less than 9% of the U.S. GDP. The real action is in corporate profits, which thanks to the weak dollar are near all-time highs of almost 14% of the entire GDP.

So those picking #3, the see-saw breaks and the dollar and stocks rise or fall in parallel, have to explain why this dynamic has broken down, and describe the new dynamic which has caused the USD and SPX to rise or fall as one.

Those picking #1, that stocks are about to rebound and the dollar will plunge to new lows, have to explain what force will drive stocks higher and weaken the dollar. The easy answer is the Fed will launch a "monetary easing" a.k.a. QE3 to goose risk assets, including stocks.

Perhaps this will do the trick, but just on a purely technical basis, the stock market has a number of arrows in its back, and nobody knows just yet if any of them are poisoned:

There are a lot of arrows in the back of the market. One of the biggest is declining volume; if volume is the weapon of the Bull, then declining volume has a distinctly bearish implication.

One of the basic tenets of technical analysis is support/resistance: key levels (often round numbers like 1,200 or 12,000) become important when stocks bounce off them (support) or are unable to punch through them (resistance). When stocks break support, then that line becomes resistance when stocks try to rise. If stocks break through resistance, then that line become support should markets decline.

When key support levels are decisively broken, huge damage is done to the market, even if the actual point drop appears modest. The SPX broke a key support level just above the pyschological line at 1,200. This has provided strong support/resistance going back to 2008, so it's meaningful.

In the typical course of things, the SPX will attempt to break above that resistance on a rebound off the strong support offered by the 200-week moving average, a level it almost kissed last week.

But there are a lot of other arrows which suggest that will be difficult. Chartists like to draw trendlines, and if we trace out all the trendlines from the 2009 bottom, we get a fan of broken trendlines. This suggests a weakening major trend.

Then there's those three indicators arrows firmly planted in the market's back; RSI (relative strength), MACD (moving average convergence-divergence) and stochastics are all diverging from the rally--all have been declining as the SPX traced out a classic three-peak "head and shoulders" topping pattern over the past few months.

If we look at RSI, we see it is not yet oversold. We also see that when things get ugly, as they did in late 2008, the RSI can actually climb out of being oversold even while the market is in a freefall. When markets are falling, RSI can remain low for months.

MACD offers a very simple window into stock trends: MACD above the neutral line, Bullish, MACD below the neutral line, Bearish. MACD is heading straight for the neutral line and if it crashes through it, it is a distinctly negative indicator.

Stochastics can stumble along an oversold bottom for months, too, so there is little evidence here of an impending rally.

There is strong support around the 1,050 mark, but the market sliced through this like a hot knife through butter back in 2008 before finding some solid ground around 900. When that failed, 666 marked the final trough.

Maybe the SPX recovers the 1,220 level, maybe not. Nobody knows how many of the arrows in its back are poisoned. We'll just have to watch support/resistance.

Those picking #2, a rise in the dollar and a corresponding drop in stocks, have to explain how the dollar can survive the poisoned chalice proffered by the Federal Reserve. The Fed's entire game plan boils down to driving the dollar down by whatever means are necessary. Many observers see the Fed as all-powerful, irresistable, with god-like powers to move markets.

But as I have noted here many times, the Fed's mighty armament is revealed as a BB gun when compared to the foreign exchange markets ($2-3 trillion traded daily), the global risk trade ($30-$100 trillion, depending on what markets you include), and global debt denominated in dollars (in the trillions).

Thus the Fed's power is not the infamous printing press, but the belief of market players that the Fed can single-handedly reverse markets. On a large enough scale, the Fed does have some leverage; for example, the Fed played some $18 trillion into global markets to save the day in 2008.

It is my contention that the Fed's political capital and credibility--the "magic" of omnipotence--have both sunk below critical thresholds (Don't Fight Bet On The Fed August 5, 2011) and that the law of diminishing returns has emasculated the market-moving value of QE3, 4, 5, etc.: each infusion to goose the risk trade does less than the previous prop job.

The timeline of manipulation has also compressed: the Fed's "save" in 2007 lasted a year, the order-of-magnitude greater "save" in 2008-9 bought perhaps a year and a half, and QE2 boosted risk assets for less than a year. If QE3 is smaller than QE2, then its effects will be entirely transitory--weeks, perhaps only days or even hours.

Dollar Bears are assuming the USD will crash through support to new lows. That is certainly one possibility--but it can only happen if stocks rise (choice #1) or the see-saw breaks (#3).

The indicators are exhibiting positive divergence, i.e. slowly rising even as price declines or noodles around a narrow trading range. The USD has traced a classic pennant or flag "wedge" of lower highs and higher lows. This compression of price action often leads to a big move up or down.

Those betting on the Fed's omnipotence to crush the dollar to new lows have to overlook the positive divergence and the previous pattern of the dollar rising dramatically when the risk trade unravels. Those betting the dollar will repeat that pattern have an easier case to make technically.

From a fundamental view, the DXY index is on a see-saw with the Euro, as the DXY is composed of a basket of six currencies dominated by the Euro (Euro 57.6%, Yen 13.6%, Sterling 11.9%, Canadian Dollar 9.1%, Swedish Krona 4.2%, and Swiss Franc 3.6%).

Thus those betting on the DXY hitting new lows are implicitly betting on a recovery of the Euro. THose betting on major dollar bounce are betting that the Euro is in deeper trouble than the U.S. dollar.

There is no crystal ball that foretells the future; when it comes to forecasting the future, we have only charts, judgment, intuition and probabilities.

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anynonmous's picture

Moodys affirms AAA

Obama to speak in 2 hours


TruthInSunshine's picture

No sane person who is capable of performing basic arithmetic needs S&P, Moody's or Fitch.

gmrpeabody's picture

Yes, yes..., but should I buy or should I sell?

And if so..., what?

;- )

Gert_B_Frobe's picture

Cliff notes for Comrade Zero's presser: (blather, blather, blather) inherited Bush's mess (blah, blah, blah) Tea Party terrorists (Iba beba prezdent, booyah) Speaking of Tea, I have to run. Tee time at 2:00. Later Suckuhs!

FreedomGuy's picture

Precisely right! More importantly after the blame everyone else blather there will be NO least no solution that does not involve more spending, bigger government and higher taxes. We are lead by a know-nothing who doesn't even really care what happens as long as there's another trip to Rio or Spain or Hawaii in it for his family.

Stares straight ahead's picture

Affirms AAA?  Did I miss something?

lunar's picture

Buffett's baby - he would even give AAAA

Stares straight ahead's picture

I guess Buffett will learn to keep his mouth shut!

Maybe he'd like to say somethun about the tea party next?

hedgeless_horseman's picture

If you liked BAC at $50 you should love it at $7.  It's almost like a 1 for 7 split.  Almost.

hedgeless_horseman's picture


If you liked BAC at $50 you should love it at $7 6. It's almost like better than a 1 for 7 split. Almost.

JSD's picture

That's exactly why we don't "pitch to bitch" here.

JSD's picture

"Yeah, ummm...I need to talk to my wife about this." "No you don't Harry."

TruthInSunshine's picture

oBLAHma is going to make a rare (/sarc) press conference appearance at 1 p.m.

Obama will  blah blah for a few minutes and then go raise more of what will be his 1 billion dollar warchest for his 2012 re-electionc campaign by pandering to Wall Street some more.

SilverDoctors's picture

Also, have to agree with your theory that Countrywide will be spun off from BAC this time.
Just too much toxic crap on that balance sheet.

Dr. Engali's picture

My view is that BAC will be loaded up with bad assets (bad bank) since they were never part of the club. Then they will be allowed to fail in a controlled (or an illusion of controlled)way.

Doyle Hargraves's picture

They already were loaded up with crap in 2008 (cunt tree wide), just been a ticking time bomb since then add in lawsuits and forced fannie/freddie repurchases they are already dead just do not know it yet...think Keith Richards.

Stuart's picture

ya, ok..  there's only two possibilities.  You live, or you die.  ..     

Diogenes's picture

Unless you do neither....... or something else happens.

Look at me I are a prognosticator.

channel_zero's picture

I pick door #1 Bob...

Why?  the top 20% are looking at the topline valuation of whatever's left in their savings and judge their fiscal health that way.  Nevermind the cost of living has increased such that the bottom 80% are poorer than ever.  Doesn't matter.  They can afford to fill the BMW and pay the kid's private school.  Everything is good!


It's like boiling frogs at this point.  Just don't turn the heat up too high.


Dow 13000 next month!

unky's picture

Gold costs almost more than Platinum, how long is this sustainable? Since Platinum is much rarer... I was just wondering

Hearst's picture

Similar argument with Silver.  Above ground stocks of Silver are dwarfed by above ground stocks of Gold and yet the Gold to Silver ratio is 43 to 1 !!


Economic law will play out and adjust these imbalances.  Until then enjoy the HFT show!

Sophist Economicus's picture

Gold will eclipse Platinum since the demand/supply factors for each metal are different -- i.e., rarity is in the eyes of the beholder...

dark pools of soros's picture

Rarity???  no no..  it's all about Tradition!!!

FreedomGuy's picture

Platinum is an industrial metal which is where more of it is used. Rarity is only half the equation. Remember it is a SUPPLY and DEMAND chart. The supply may be low but the demand due to crashing economy and Japanese auto factories idled drive the demand lower. So, it actually makes sense along with palladium and even silver. Silver has a larger money component so it will waffle in between.

Irish66's picture

When do all are banks get halted?

John McCloy's picture

  Wow BAC is about to cross over into the 6's.

Spitzer's picture

There will be deflation in the US priced in Euro's, not dollars. Look at the problems in Europe yet the Euro is still above parity.

DaBernank's picture

Our problems are just getting started over here in Europe and the people on the street know it. Current trading/speculative Momo *price* of € is 1.42. True *value* of € is trash because of lack of mechanisms to deal with the massive debt levels of all nations (even Germany is at 83.2% GDP), ECB has only 550 tons gold, there's wide disunity of cultures/identities. Nationalist parties have already gained momentum in many nations. Breakup is inevitable.

FreedomGuy's picture

The Euro! It was fun while it lasted, right, lol? It has the same problem as the welfare state. Countries like Greece and Portugal ride the higher ratings and bailouts like a national welfare case, just like welfare recipients live off the higher productivity of others.

anynonmous's picture

just saw a clip with Zandi

his trousers were on backwards

tekhneek's picture

D) Stocks crash, dollar crashes, precious metals sky rocket.

YHC-FTSE's picture

That's what is happening now. Gold and Equities are diverging, when traditionally they ran parallel during uncertain times. What happens when stocks pick up? And please don't tell me we won't see QEiii. I hate to say it, but it doesn't look good for gold especially after JPM announced $2500/oz. I'm still buying, but volatility is not what I want in gold, and a collapse is not what I want for my country (UK). 

chartcruzer's picture

if any would like to monitor this in real time has the great debt bubble burst unfolds.[s224230059]&disp=P

the more interesting releationship is that of gold and the SPX

here's the relative peformance of the SPX to gold[s240729620]&disp=P

DaBernank's picture

I will buy BAC at Family Dollar, for $0.99... ahhh who am I kidding, I'd rather watch a $1 bill burn.

THE DORK OF CORK's picture

This is a really tough one for the average sacred shitless Euro Dork who holds Gold & Euros earning decent interest & possibly Francs

Physical dollars may be a option as a European collapse hedge but they look like friggen toilet paper.

Escapeclaws's picture

This just goes to show that anyone can read charts and interpret them. This is as good as other chart interpretations out there. Distinctly better than that offered by the Smartknowlegeu.

Flakmeister's picture

CNBC just singalled a sell signal for gold....

Tuesday will be "Gold Rush" day....

Sell your calls or buy some cheap puts....

And No, I am not a troll

chistletoe's picture



There is a fourth possibility, which I believe is a whole lot more likely

than any of those three.


To quote a wise sage,,

"On a long enough timeline the survival rate of everything goes to zero ...."

narnia's picture

Promises made by governments or those dependent on them are worth ZERO.  Assets that are neutral or counter-productive to the quality of life of humans have only salvage value.  Assets that improve the quality of life of humans have REAL value.

The settlement of worthless promises and liquidation of the neutral or counter-productive assets are both going to happen.   

treemagnet's picture

Euro's gonna go humpdy dumpdy, and all the kings horses and all the kings men couldn't put 'er together again.  Dollar up hard temporarily and stocks take a header.  Theres my call.

Mr Lennon Hendrix's picture

The dollar is not going to rise concidering that not only does the Fed burn dollars for leverage, now the ECB is throwing Eurodollars into the fire.  The dollar is doomed.

Now that gold has hit resistance, Bernanke will sell (make his loans) and use the cash and leverage to issue QE 3.  Gold will go to support, and then the PPT will pump cash into equities, and monetize the debt.  Then next winter, the financial system spins it wheels once again.  Wash, rinse, repeat, until there is no more fiat from the taxpayers, and gold is at $10k.

Gold Chart from 99er's Blog:

Mugatu's picture

This quote is so stupid:

"Dollar Bears are assuming the USD will crash through support to new lows. That is certainly one possibility--but it can only happen if stocks rise (choice #1) or the see-saw breaks (#3)."


So he is saying that equity prices drive currency movements?  I know currency traders who never even look at equity prices all week - gee this guy must know some secret everyone else who trades currencies doesn't.    It is more the other way around - currencies move equities.  The tail does not wag the dog!

MrSteed's picture

An entire article without "cargo cult" or "simulcrum".  Sweet!

oogs66's picture

wasn't the 3rd possibility really 2 possibilities?