The Trader’s U E-Letter: Issue # 161
Wednesday, November 16, 2005
The U.S. Dollar: Strong or Weak? (The Dollar Is Dead. Long Live the Dollar!)
by D.R. Barton, Jr., Chairman, Trader’s U
Newsweek is one of my favorite investing tools.
Yes, you read that right. When it comes to jumping on the bandwagon at the very end of a big market trend, it’s tough to beat Newsweek. Of course, you can really substitute the name of any news weekly in here (I don’t mean to downplay the ability of Time or U.S. News and World Report to jump in at the end of a trend).
But invariably, the news weeklies only pick up market trends when they have gotten frothy. And a cover article on a financial topic in any of these magazines almost always means we’ve hit a top or a bottom.
This was certainly the case at the top of the Nasdaq bubble. I remember visiting friends in Pittsburgh in early March of 2000. On their coffee table were the current issues of Time and Newsweek. The title for the Newsweek cover article is burned in my memory: Amid stock market tickers and symbols was the bold question of the day, “Aren’t You Rich Yet?” And the Time cover story was very similar.
Rumors of the Dollar’s Death Have Been Greatly Exaggerated
In March of this year, a similar topping process was taking place in the value of the U.S. dollar. Every pundit and talking head who could get air time was shouting about the death spiral of the dollar. The end was near and the euro would rule. But I saw some things differently, and said so in print.
In an article I wrote for Van Tharp’s newsletter on March 16, 2005, I stated bluntly, “I smell a bottom in the dollar.” (A week later, on March 22, my good friend Dr. Steve Sjuggerud wrote an elegant article where he also gave his view that the dollar was bottoming.)
One of the main reasons I thought the bottom was in for the dollar was a theme issue of Newsweek that hit my mailbox on March 15. The cover story was titled “The Incredible Shrinking Dollar.” Articles explained all of the macro reasons why the dollar was weakand going to continue to slide into oblivion.
While reading magazine covers may seem a little simplistic, it is a valid tool in understanding overall market sentiment.
And the fact that news weeklies jump on the bandwagon late, or even at the very end of major moves, is really quite predictable. Most people take a very long time to be convinced that something is happening. They want proof, proof and more proof.
The problem is that when the market has provided enough proof for most people to be convinced, it is already overextended. Such was the case with the dollar. It took a four-year bear market in the dollar to get the mainstream press’ attention. And by then, the bear run was ready for a breather.
The dollar has indeed strengthened significantly since March. But it has reached an interesting decision point. Let’s look at how to play the dollar in the short and intermediate term.
The Strong Dollar: Quietly One of the Year’s Success Stories
The dollar has gained an amazing 21.5% against the euro in the 2005 calendar year. Why don’t you hear much about that?
Gloom and doom sells. Especially when Goliath (in this case, the U.S. economy) is seen as the one getting pushed around. When the dollar was making new lows versus the euro, like it was earlier in the year, there were lots of articles on how bad things were for the dollar and how much worse they would get. I guess reading gloom and doom is a bit like watching horror movies – people get a weird sense of pleasure in scaring themselves.
But with the dollar strengthening significantly this year, we don’t see quite so many articles declaring that the sky is falling.
However, doing an autopsy on media reporting tendencies doesn’t help us understand what the dollar is doing now. Here’s a chart showing weekly bars of the euro’s value in dollar terms (the scale on the right shows how many dollars one euro is worth).
First, please note that in the world of Foreign Exchange (or Forex) currencies, the currency pair for the euro and the U.S. dollar is charted in terms of “dollars per euro.” This means that when the chart moves down, the dollar is strengthening (versus the euro), and when it moves up, the dollar is weakening (versus the euro).
So we can see that from late 2000 and early 2001, to early this year, the euro strengthened and the dollar weakened.
But since early 2005, the dollar has strengthened significantly.
Temporary Strength or Longer-Term Trend?
Will the dollar continue to strengthen, or will it lose value from here? Our first clue and decision point comes from the chart above. We’ll look at the retracement levels of the dollar.
After the four-year weakening of the dollar (euro rising), we went from 0.8226 dollars per euro all the way up to 1.3666 dollars per euro. As the euro moves down off of these highs, technical analysts look at key retracement levels that will decide whether the trend continues or reverses.
The first level is a retracement of about one-third of the big move. And we are just now bumping up against that level. This zone of support is at about 1.1600 dollars per euro. If the trend keeps heading through this level, then reaching the 1.1000 dollar per euro (the 50% retracement zone) is a very high probability.
I expect a battle to take place in the 1.1580 to 1.1620 range. But over the next few weeks or months, I expect this zone to be broken, and we’ll travel down to the next support level at 1.1000 (which represents a 50% retracement).
There is one big reason for this expectation of continued strength in the dollar versus the euro. And it comes from (surprise!) fundamental analysis. The European Union (EU) is a political mess right now. Germany’s government is in a handcuffed standoff as power is transitioned. France is experiencing troubling civil unrest. And multiple countries have refused to ratify the EU constitution.
All of this political angst, when coupled with a continued rising interest rate environment in the U.S., points to money flow favoring the U.S. over Europe.
Next week, we’ll look at possible ways that you can trade or invest in the U.S. dollar (there are many!). Until then
Great trading,
D.R.
Today’s TU Tips & Tricks
- If you find it enjoyable, or at least useful, to keep up on international news and financial issues, I know of no better place than The Economist. Its articles are well-researched and well-written. And since it’s a British publication, it provides a refreshing departure from the U.S. media machine.
- For more on frothy tops, take a look back at Trader’s U #150, Investing in Oil: Is Black Gold Finally Topping Out With Katrina’s Help? and #157, Are Oil Prices Still Driving the Market?
The Chart of the Week
Microsoft (Nasdaq: MSFT) has been receiving some press (most notably in Barron’s) about being a value stock. You read that right – a value stock. As it approaches its high for the year ($27.94), it could be a potential breakout play. If the MACD continues to rise, it will be confirming for the new high and MSFT could be a momentum buy above $28. Give it a very short leash, though – tight stops are recommended when playing breakouts (they should either work quickly and keep moving up, or you should get out).
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