foxex: Can a Strong Dollar Derail the Bullish Train?

Chart Advisor | Focus on the Price

By John Jagerson, CFA, CMT

Tuesday, February 12, 2019

1. Buying into the close

2. S&P 500 breaks to new highs

3. Strong dollar impacts overseas earnings

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Major Moves

Traders on Wall Street are interesting creatures. Sometimes you never know what they are going to do, and sometimes they fall into rather predictable patterns.

While it can be difficult to quantify, it often seems that intra-day trading patterns seem to develop more frequently than day-to-day patterns as traders try to adjust to fluctuations in the broader market.

We're seeing one of those intra-day patterns emerging right now.

Traders have been pushing the S&P 500 higher during the last 30 minutes of trading for the past few weeks. This phenomenon has occurred on days when the S&P has closed higher for the day and on days when it has closed lower for the day.

Historically, seeing traders buying into the closing bell is a sign of confidence in the days ahead. When traders are confident, they tend to add to their positions. When traders are nervous, they tend to trim their positions – especially heading into the uncertainty of overnight hours or the weekend.

Seeing traders show enough confidence in the U.S. stock market to add to their portfolio during the final half hour of trading each day is a good sign that the S&P 500's current bullish move still has plenty of momentum left.

S&P 500

The S&P 500 broke up to new highs for 2019 on the heels of the news that Congressional leaders have reached a resolution to fund the federal government and avoid a shutdown and that negotiations between the United States and China seem to be progressing.

Although neither announcement is a done deal, the removal of potential uncertainty from the market has been music to Wall Street's ears. Wall Street hates nothing more than uncertainty.

After hitting down-trending resistance on February 5th and 6th, the S&P 500 successfully re-tested former resistance at 2,675.47 to see if it would hold as a new support level.

Now the S&P 500 has broken above 2,738.98 – the high from February 5th – to establish yet another higher high in the dramatic uptrend the index has been in since bottoming out on December 26, 2018.

This move puts resistance at 2,820 within shooting distance.

Projecting ahead a few months, if the S&P 500 climbs to 2,820 and then consolidates below this level for a while, it could eventually form a long-term inverse head-and-shoulders bullish reversal pattern.

Of course, this is pure speculation at this point, but it is always helpful to visualize what might occur on your charts in the future so you can recognize the signals when they happen.

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Risk Indicators - USD Double Bottom

The U.S. dollar (USD) has been getting consistently stronger since mid-February 2018.

The USD first started to gain strength as the Federal Open Market Committee (FOMC) signaled it was going to be consistently raising interest rates during 2018, which it did. The FOMC raised the Federal Funds rate four times last year.

Currencies tend to gain strength when their associated central bank raises short-term interest rates. Higher short-term interest rates tend to push longer-term yields higher, which makes investments in longer-term government bonds more attractive.

Typically, you are required to pay for government bonds in that country's currency so foreign investors are forced to convert their currency into the local currency. This boosts demand for the local currency which increases the value of that currency.

As an increasing number of foreign investors were drawn to U.S. Treasuries as the 10-year Treasury yield (TNX) jumped as high as 3.25% in 2018, demand for the USD increased and so did its value.

However, the FOMC has pulled back from its interest rate hikes and has even signaled it is going to slow down the wind down of its balance sheet, keeping U.S. monetary policy more accommodative than previously anticipated.

This turnaround from the FOMC has sent the TNX back down below 2.7%, but the USD is still gaining strength.

Government bond yields aren't the only driving force in the currency market. The strength of one economy compared to another can also drive currency value fluctuations.

Currently, the USD is gaining strength against the euro (EUR) and the British pound (GBP) as "Brexit" concerns and a slowing European economy make the USD look like a superior value.

While this is good for Forex traders who are long the USD, it's not so good for multi-national companies that generate a large portion of their profits overseas and repatriate them to the United States.

When the USD is weaker compared to other currencies, multi-national companies make a better return on foreign-generated profits because of the exchange rate. For instance, if the exchange rate shows that €1 = $1.20, a company that generates €1 million in profit in Europe will book a profit of $1.2 million at home.

Similarly, if the USD gets stronger and the exchange rate shows that €1 = $1, a company that generates €1 million in profit in Europe will only book a profit of $1 million at home. Nothing changes in the performance of the company, but its earnings decrease by $200,000 because of the change in the exchange rate.

If the USD continues to strengthen, watch for the earnings growth expectations of large multi-national companies to be impacted negatively.

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Bottom line: Sea of green on the heatmap

Not every stock that is part of the S&P 500 rose today, but most of them did. The heatmap of the index shows a sea of green as every major sector saw strong growth.

Seeing traders buy into the bullish move with both hands today gives us confidence the bullish sentiment is here to stay for the rest of the quarter – barring any unforeseen surprises.

The rising U.S. dollar could complicate earnings growth in future quarters, but Wall Street seems prepared to shrug that off for now.

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