Charting Stocks

The Dow Jones Industrial Average breached the 10,000 level at the open and then rallied back 180 points from the low to close at 10,193. In a previous post I mentioned that the major averages were close to major support levels while approaching oversold levels. Those levels were tested today before the market moved higher.
(Chart 1)

One of the key inter-market relationships which has emerged since 2001 or so, is that stocks tend to go down as the dollar strengthens while advancing on dollar weakness. On Tuesday, I informed my readers that the dollar was overbought and seemed due for a correction. As it turned out, Tuesday was the last day the dollar strengthened and dropped for 3 consecutive days (Chart 2). Weakness in the dollar is good for stocks.

Why the wild swings in the US dollar? Europe. The US Dollar index measures the currency against a basket of other foreign currencies, the largest of which being the Euro.  A sharp decline in the Euro would, by default, cause an increase in the value of the US dollar. Not to mention the panic liquidation of European assets and the money flows back into the US via the treasury market.  Chart 3 clearly shows the relationship between stocks, the euro and the dollar through the European crisis.

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After dropping 376 points yesterday, the Dow Jones Industrial Average is set to open down 95 points which would put it below the psychologically important 10,000 level. In my previous post, I mentioned that the ‘flash trade’ prices were real and we were heading for a retest of those lows. Currently, the major averages are now trading in oversold territory. That’s the good news. The bad news is that if the February lows are breached, it raises the odds for steeper losses.

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Both the Dow Jones Industrial Average and S&P 500 Index are trading below their 200-day moving average.  NASDAQ bucked the trend bouncing back above it 200-day MA.

Many analysts in the technical community were unsure if the ‘flash trade’ lows were actual prices which should be included in their analysis, or merely a ‘machine’ blip which can be ignored. As the days have progressed, however, it’s become increasingly clear that the flash trade lows registered in the major averages were indeed real prices and are close to being retested.

My opinion has been that the numbers were real and should be included. The charts of the Dow, S&P 500, and NASDAQ below show that even during those infamous 10 minutes of panic, buyers entered the market close to major support levels (the February lows).In all three examples, the February lows held.

After the initial reactionary bounce back, all three major averages resumed their downward trend and appear headed for a test of the ‘flash trade’ lows. Support for the major averages lies between the February and ‘flash trade’ lows.

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Chart of the Dow Jones Industrial Average priced in ounces of gold since 1968. The data set used divides the DJIA annual closing price by that years average gold price. Because this is annual data, some of the extreme monthly readings are smoothed out.

The bottom, in our example, occurred in 1980 when the ratio was 1.57. The closing price for the Dow Jones in 1980 was 963.99 while the average price for an ounce of gold was 614.61 that year. Alternatively, the peak occurred in 1999 as the Dow ended the year trading at 41.27 times the average price of gold for that year. The average is 14.23.

The selloff of in the price of crude oil may soon reverse as it’s become oversold (RSI below 30). So far, price has remained above the February lows which further supports our conclusion. The oversold condition shouldn’t come as a surprise since crude oil is priced in US dollar throughout the world and the dollar is overbought. As the dollar strengthens, the price of oil decreases and vice versa.

Stocks trading in Shanghai are off 25% from their cyclical bull market peak 0f 3500 which was reached in the summer of 2009.  A decline of more than 20% is viewed by many as bear market territory. According to The Vanguard Group “there’s no agreed-upon definition of a bear market, one generally accepted measure is a price decline of 20% or more over at least a two-month period.” Shanghai now qualifies.

The secular (Long Term) trend remain is bearish as well as the cyclical rally failed to decisively reach above the 38.2% Fibonacci level. A bear market in China can directly effect global equity markets as noted here.

There have been a few bright spots in the current selloff. Short (Inverse) ETF’s, which move in the opposite direction of the underlying index, bottomed in April and have been rising since. Volatility, Treasuries and the US Dollar have also been moving higher. The Dollar, however, is overbought as discussed in this previous post.

Proshares Short QQQ Fund (NYSE: PSQ) is the inverse of the NASDAQ 100 Index (First Chart). Proshares Short S&P 500 (NYSE: SH) moves in the opposite direction of the S&P 500 Index (Second Chart).

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European liquidation has put upward pressure on the US dollar causing  the price level to reach an extreme. While securities/currencies can become overbought while staying overbought, the recent overshoot suggests a pullback is on the horizon for the US Dollar in the coming weeks. Recent RSI readings of 70+ (overbought) have preceded a decline.

Contrarily, in September 2009 we mentioned that the dollar was oversold and a move up was on the horizon. We mentioned that such a move would put pressure on stocks and commodities. The environment seems to have reversed. If the dollar does weaken in  upcoming weeks, it should be positive for stocks and commodities.

Billionaire investor Warren Buffet did some heavy selling during the first quarter of 2010. According to the most recent 13-f filing, Mr. Buffett liquidated his entire position health insurers United Health (UNH) and WellPoint (WPT). He dumped his holdings in financial companies Travelers (TRV) and Sun Trust Banks (STI).

Buffet also trimmed his holdings in 8 stocks while increasing positions in 3.

Positions were reduced in Conoco Phillips (COP), Carmax (CMX), Costco (COST), Johnson & Johnson (JNJ), Gannett (GCI), M&T Bank (MTB), Moodys (MCO) as well as Procter & Gamble (PG).

Buffett reported an increase in holdings in Becton Dickinson (BDX), Iron Mountain (IRM), and Republic Services (RSG).

The total value of Berkshire’s portfolio dropped $7 billion to $50.9 billion from $57.9 billion in the previous quarter.