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November 7, 2006

Suckers Rally

Watching today's action, two observations struck me as being potentially important. First, the dollar got slapped around again and has been in a month-long rut. Over the last two years, the dollar has certainly seemed to dominate the mindset of traders, attested by the fact that every significant turning point for the U.S. Dollar Index has preceded a significant turning point in the S&P 500 by 4-6 weeks. Will the downturn that began in mid-October turn out to be an important one? We do not know, but note that the index edged below its 6-month support line today before recovering to close above it. The next two weeks will be critical.

stock chart

Second, the bearish momentum divergences on the SPX and NDX have become more pronounced during our two-day power rally, particularly in the NDX.

stock chart

I have a growing suspicion that this rally is providing the final twist to a market trying to fool the most number of participants. The bulls, who were shaken last week, have renewed confidence, while the bears, who were prematurely emboldened last week, are now exasperated. Throw in a growing number of traders anticipating a repeat of the end-of-year ramp script, and there are few left who believe a significant downturn could start presently.

For now, all eyes are on the election, but whatever the market does in the wake of today's polling will have little to do with the election results. I believe the market already knows what it wants to do and will draw a reason to do it from whatever election outcome we see.

I was a bit disappointed to see metals modestly lower while the dollar was getting clubbed. On one hand, we metals bulls could simply say a breather was due after the big moves of the last two weeks. On the other hand, metals could be flashing a warning signal that the dollar is not due to break down significantly just yet. If the latter hand is the valid one, the case I made above for a potential market turning point is significantly weakened. I don't want to outguess myself by connecting too many dots, though, so let's keep our eyes on the dollar and try to get a read from the market's initial reaction to the election.

Disclosure: None


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