Dollar Reversal May Unwind The Presumptions Behind the September to Remember Rally

The Dollar has continued the break up since Friday. The reversal has been strong and has all the earmarks of a short squeeze. As I noted a few days ago, the net short position was quite large. This chart from Credit Suisse shows how deep the Dollar bearishness got:

The break up has formed a nice 1-2-3 pattern, which under ewave suggests it has more to run in wave 3 and beyond. It has also bifurcated out of the recent trading range, which under Fractal Finance means we have a trend change, unless it reverses quickly back down. The STU yesterday was written by Peter Kendall, who has a different style than Steve Hochberg who normally writes it, and as it has for several issues, it started with the Dollar. The bounce since Friday traced an initial five-wave pattern and corrected yesterday in three waves. The strong move today confirms the change of trend up. You can see the bifurcation above the recent trading range, and the turning up of key sentiment indicators, in this chart from EWTrends:

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If this Dollar Reversal continues, the most immediate impact should be on commodities and gold. Oil and gold fell today. Treasury yields have reversed up in the last few days, despite the overhang of QE2.

The most interesting move today came from China, where the PBOC raised rates for the first time since 2007. China continues to be concerned over inflation and other signs in internal overheating. Growth in Europe and Japan has been turning down, and China may follow. The global economic recovery may be topping.

Optimism still rules in stocks. Carl Futia sees a short-term consolidation before a continuation of the uptrend, targeting 1300 by April 2011. Goldman Sachs has provided their guidance, with targets of 1200 by YE and 1275 within a year:

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What is noteworthy is Goldman sees continued earnings growth but fading PE, and hence less of a rise in the S&P even as earnings get back to 2007 levels. Carl’s key chart also shows a triple top in the e-mini followed by a bifurcation below the recent trading range, which under Fractal Finance indicates a top, not a consolidation:

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The case for bullishness rests largely in fundamentals: QE being good for stocks, and continued earnings growth. If the Dollar Reversal continues, score one for technical analysis, since the overhang of QE would not have caused fundamentalists to expect the bounce. So what about stocks?

One of the better technical indicators at a top is to watch the leaders fade against the trend. While Google popped well after their earnings, Apple, IBM and Amazon all showed weakness. Apple in particular may have been priced to perfection, and yet the reason for the drop after hours yesterday seems spurious: while revenues and earnings blew away expectations, iPad sales were lower. Being in the Silicon Valley community, it is clear that iPad missed due to supply not demand. Apple is selling every iPad they can build. Hardily the cause for pessimism. Perhaps Apple will be back on trend in a few days, but if it and the other tech leaders lag despite good fundamentals, it signals a reversal brewing.

Nowhere is this clearer than with bank stocks. They led the rise off March 2009, and were a huge percent of both earnings growth across the whole S&P and market volume. Facing all kinds of pressure due to foreclosuregate, including threats of buyers of their toxic junk wishing to put it back, financial stocks may be in for a tumble. And indeed, Shanky noted over the weekend (and I also received charts from readers via email) that the banking stocks were noticable laggards:

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The bears are being cautious, but some are growling. PrincipalAnalysis thinks a big drop is next, and gives levels that would change his view: SP1177 and Dow 11068. The drop looks like a reverse of the Dollar break up, being a wave 1 down, a wave 2 correction,and now we appear to be in 3 down. The levels to watch are the wave 2 highs, which should not be broken if a big drop is right ahead:

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