Two Key Indicators that Stock Market Timers should be Following

The major U.S. and global stock market indices have staged a rally for the ages since March of 2009, even though economic conditions continue to deteriorate.  For those who are trying to ride the market-timing roller coaster by following the momentum and direction of the S&P 500 and the Dow 30 there are two key indicators that they should be watching closely.  They are the U.S. Dollar vs. the Euro and the Shanghai stock index.

• The second most important indicator to monitor is China’s Shanghai stock index.  It has led and will continue to lead the rest of the world’s stock markets.  This is because China has the world’s only large economy, which has been growing.  With a growth rate of 7% it is blowing the doors off of all of the developed countries and their economies, which are growing at under 1%.   

• The primary and most important indicator is the U.S. Dollar.  It is leading the Shanghai index.  The reason why is because the exchange rate for the Yuan, China’s currency is fixed to the U.S. Dollar.  Therefore, any weakness in the Dollar decreases the prices of the goods that the Chinese are exporting.  A weakening dollar equates to an increase in the growth rate of China’s economy and a strengthening U.S. Dollar creates the exact opposite effect for the Chinese economy. 

The Dollar is the primary indicator because any significant strength in the Dollar for whatever reason will have a significant negatively impact the Chinese economy and its stock market.  For example, should there be an economic debacle that does not involve China, the Chinese economy and stock market would be negatively impacted if investors fled to the Dollar.  On the other hand a gradual decline of the Chinese stock market would not necessarily have a positive impact on the Dollar.  

The two significant indicators are becoming more intertwined and are now having a much bigger impact on each other.  The reason why is that a sharp decline in the Chinese stock market would increase the flight to safety and thus increase the demand for the U.S. Dollar.  A sharp decline in the U.S. Dollar has a significant positive impact on the Chinese stock market.  The incestuous relationship between the two is very bad for the global economy because a low dollar increases the prices of all of those goods, which are being manufactured in Europe and decreases the exporting capability of that region of the world. 

The world has become dependent on China’s economy to grow the global economy out of its recession and China has become dependent on an ever-weakening Dollar to grow its economy.  There are two problems with this scenario. The first is that a lower dollar chokes off or reduces the ability for those countries that utilize non-dollar denominated currencies such as Euro, which do not have exchange rates that are tied to the Dollar to export.  The second is that the volatility between the U.S. Dollar and the Euro has increased to its highest ever.  The foreign exchange relationship between Dollar and the Euro has gyrated or increased and decreased by over 10% four times within the last 12 months.  This compares to only one up move over the previous 12 month period when the Euro climbed by 10% against the Dollar and a total of only four moves of 10% or greater in the previous five years.  Each peak in the Euro has coincided with a peak in the U.S. market and each trough of the Euro has coincided with trough in the U.S. stock market.  The chart below depicts this pattern: 

The increased volatility of the foreign exchange rates for the world’s two biggest and most liquid currencies means that major U.S. indices are currently riding roller coasters, which are currently much closer to their peaks than their troughs.  Can the Euro and the major U.S. stock indices go higher?  Certainly, but with each percentage point increase the probability of that happening will lessen.  Also, at this point there is no reason to believe that the volatility of the currencies will lessen.  The highly volatile currencies, the extended bear market rally and the most bullish investor sentiment (Those investors who are bullish outnumber those that are bearish by 2 to 1) since 2007, the likely result is that the U.S. stock market will soon take a another ride down the roller coaster. 

Tracking the Euro/Dollar relationship and the China’s Shanghai market index will enable those long investors to get off at close to the top and give their seats up to those short investors who want the thrill of riding the roller coaster to the bottom.

My opinions on General Electric (NYSE:GE) as a short candidate and for Etrade (ETFC) as a long candidate remain intact.  GE has a mountain of credit problems or loan write-offs that it must eventually face.  Etrade currently participates in one of the few industries in the U.S. that is positioned for secular growth. 

For more information on why I believe that the U.S. is currently in a Super Bull market, which will last until 2015 and how investors can make as much or more in the current Super bear market than they did during the 25 year Super Bull market which began in 1982 and ended in 2007 go to www.bearmarketnavigator.com.