Market Signals Increasingly Confusing

July 15 increasingly looks like an intermittent or possibly even a bear market low for U.S. equities. Judging by the technical picture painted by homebuilders, real estate investment trusts (REITs) and the U.S. dollar, investors might finally make some money in the stock market over the next several months.

But before getting too hot and heavy consider the state of credit.

I’ve been writing intensively about the credit markets all summer, suggesting that we’re long from a bottom in credit contraction. That remains the case this morning with most credit spreads still widening as stocks head higher. But the stock market is clearly sending bullish signals in several key sectors that seem to be forming a bottom.

One sector that appears to have bottomed this summer is the homebuilders.

Over the last 12 months the XHB Index (see above) has posted two major declines followed by significant recoveries; the first bounce last February turned out to be a fake-out as XHB plummeted to new lows in July. Now we seem to be in the midst of another uptrend for this index. Currently at $18.93, if XHB closes above its 200-day moving average of $19.53 that would be considered bullish.

The dollar is probably the single most surprising event this summer.

From its low in March, prior to the Bear Stearns’ bailout, the dollar sank to as low as 1.61 euro intraday. This morning the euro is opening at 1.473, an 8.5% decline. And gold prices are now suffering their worst correction since the summer of 2006, down 22% since its March all-time high.

The U.S. Dollar Index is now trading comfortably above its 200 and 50-day moving averages. That’s bullish.

The $1,000,000 question is whether this dollar rally has legs or is it another in a long series of bear market rallies that will eventually crash?

I’m still not 100% sure what to make of this market action. Credit markets are still bleeding but the stock market and the dollar are strong. Basing patterns by REITs and homebuilders are also bullish. If the Dow Jones Transportation Average, just 6.3% off its all-time high, breaks that record I’d be further encouraged. But the Dow Industrials MUST confirm the Transports if the latter breaks to new highs. So far that has not happened.

Here’s what I’m doing: If the S&P 500 Index closes above its 200-day moving average over the next several days – a 5% rally from current levels – then I’m going to reduce my cash positions and cut some market hedges. I’m also going to buy an S&P 500 Index ETF.

The U.S. equity market, long a dog, might start to produce some eye-popping returns for dollar and foreign currency-based investors. That’s been the case since July as foreign stock benchmarks are flat or barely up at all while U.S. stock indices have gained about 8%. A rising dollar negates your foreign equity returns – something we haven’t seen in eight years. That might be changing.

Have a good weekend.

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