A Case for a Dollar RallyOct 12, 2012
Chad Karnes, CMT
The dollar market is the largest in the world and impacts all other asset classes. Recently, opinion and sentiment has been very bearish. What does this mean for the dollar going forward and why should you care?
On 2/15/05 Alan Greenspan made a statement that at the time flew under the radar and didn’t capture the public’s attention like it probably would if Ben Bernanke made such a statement today. Greenspan said to the Senate Banking Committee concerning Social Security, “We can guarantee cash benefits as far out and at whatever size you like, but we cannot guarantee their purchasing power”. Given statements such as these and the recent Fed actions of QE-forever, why then am I bullish on the US dollar?
In our October ETF Profit Strategy Newsletter published 9/21, I laid the groundwork for why the US dollar is a good buy. That trade has worked out well and the trade-weighted US dollar has risen over the last month from its low on 9/14 around $78.50 to around $79.76 on 10/11. (While it may seem like a small gain, a 1% plus move for a currency is big.)
What Everyone Else Thinks
One of the reasons I'm bullish on the dollar, besides technicals, is overly pessimistic sentiment. The short dollar trade is a crowd favorite, and when trades get popular they're often wrong. This is easily seen from just the last 2 days of headlines which imply a bearish dollar and bullish Euro (NYSEARCA:FXE):
“Why Bad News from Spain is Good News for the Euro” – Marketwatch - 10/11/12
“Euro Shrugs off Spanish (NYSEARCA:EWP) Downgrade” - Nasdaq 10/11/12
“Dollar Index Falls more after Beige Book” – Marketwatch – 10/10/12
“Euro Rises Versus Dollar on IMF” – Reuters 10/11/12
Every day there are news articles trying to justify the daily swings of the markets, currencies (NYSEARCA:FXY) included. Do these headlines and articles really help us decide the direction of the currencies?
There are numerous opinion surveys that reflect the public and investor sentiment on the dollar and other currencies and assets. Bloomberg, Ned Davis, and Market Vane are a few of these.
When public opinion as measured by these surveys reach extremes, a turning point in the asset is usually very near. Counter-intuitively when opinion hits its most bullish is usually when tops occur and when sentiment is most negative is usually when bottoms occur. Therefore, you should likely take a contrarian approach and the opposite of the popular opinion.
In September negative sentiment in the US dollar hit a level that had not been seen except a few times in the past; coincidentally when the dollar was just about to bottom. This sentiment continues, and I expect it to continue to propel the dollar higher.
Technically the dollar has formed a bottom with trendline support from 2011 at September’s lows and shown in the chart below. This support held again in early October and should keep providing the buyers needed to propel the dollar higher. The September low also occurred in the typical Fibonacci correction level between 38.2 and 50%.
In our October Newsletter, we identified the dollar ETFs such as the PowerShares DB US Dollar Index (NYSEARCA:UUP) or the PowerShares 3x levered equivalent (NYSEARCA:UUPT) as ways to take advantage of this trend. Both of these trades are up and we continue to be bullish on them. We also identified target levels as well as appropriate stop locations that will help lock in profits as the rally continues. We update these levels in our minimum twice-weekly Technical Forecast.
Knowing which way the dollar is headed has much larger implications than what appears on the surface due to its highly correlated nature with other assets, especially the stock market (NYSEARCA:IWM). Given the size of the dollar market, it is the proverbial gorilla in the room. In the article found here I discuss the dollar’s importance in the macro environment in more detail.
The ETF Profit Strategy Newsletter monitors global events and formulates profit strategies based on fundamental, technical, and sentiment research so that investors can be on the right side of the market.
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