The Dollar Correlation Myth.

Last Friday, is year-end for many funds. Monday they can "legally" sell.

Monday also begins the first week of November when the three-week bias we mentioned at the beginning of the month culminates. While the market has held up into month-end, fiscal-year end, it hasn't blown off. It’s been choppy and mixed with earnings providing more than the usual Gapism.

Once again, Friday’s early strength was faded but longs came in with a late-day buy program to rescue the session as the S&P was magnetized to the pivotal point of 1184 on the close. Remember 1184 is opposite the time of the late August low and squares the important January high to open the year as it's 90 degrees from that price high of 1150. It's also roughly 90 degrees from the 1220 April high, which is by definition then opposite the end of October.

These squares may be playing out in a six-month top-to-top cycle.

In addition, 1184 is opposite 1115, which is the midpoint of this year’s range.

The March ’09 S&P low at 666 was a 75-point "undercut" of the November 21 low of 741. A 75-point "overthrow" of the midpoint or balance point of the year is 1190. The S&P has been oscillating around 1180 to 1190 all week.

Previous Friday’s close was 1183. Last Friday’s close was 1184.

If gold itself doesn’t start back up strongly by Monday, it suggests it will pullback for another three weeks or so possibly testing the 1230ish level.

The dollar seems to dictate the direction of everything lately. But is this inverse correlation to a declining dollar and rising equity prices overcrowded? Is the notion even true? Does the notion of the dollar devaluation/asset inflation trade always hold true to form?

Let’s look at a weekly chart (above) of the dollar from 2008 versus a weekly chart of the S&P from 2008.

The dollar declined into March/April 2008 in concert with stocks (A).

Notable is the marginal overthrow by the dollar in the first week in March 2009 that marked the precise low tick in stocks. The high tick in the dollar corresponded to the low tick in the S&P (D).

The November 2009 low in the dollar preceded the January high in stocks (E).

Note that the April high in stocks (F) didn't coincide with a top in the dollar. The dollar continued higher to challenge the 2008/2009 highs. The dollar/stocks correlation broke down April to June as the euro got smashed. There were other concerns. "Other" concerns could cause an unwinding again. It is interesting that the decoupling in question this past spring covered the period when the flash crash occurred. Happenstance?

From point E to point F the stocks and dollar advance is positively correlated. Both rose in unison. However, the dollar accelerated strongly in April as stocks topped and declined. Both the dollar and stocks topped in unison (G) in April and declined into the summer.

From the summer into October this year the dollar turned down again while stocks turned decidedly higher: The inverse correlation resumed.

While the market has essentially advanced from March 2009, the dollar has made two round trips.

The tip-off that March 2009 was a low in stocks was the marginal overthrow by the dollar that month over the prior swing high at 88.46 and the outside down week in March 2009.

If there's anything I've learned in my trading career it's that correlations come and correlations go and when they become too popular, they can get unwound violently.

It may be that the inverse correlation resumes here with the dollar staging a rally and stocks going lower, but they could just as easily go their separate ways.

With the election, FOMC, and G-20 in November where leaders will tackle the race to debase their respective currencies, volatility could explode.

Moreover, it's the two-year anniversary of the November 2008 crash low. We got a spring 2009 undercut of the November 2008 spike low. Is it possible we're getting a November spike high to a spring pivot in 2010.

Checking the weekly chart of the S&P and drawing a live angle up from the "true" low of November 2008 and tagging the important July 2009 low shows what may be a bearish backtest. In other words, following the break of this live angle in the summer, the S&P has snapped back to kiss the underbelly of this angle. However, the first "kiss" was rejected in early August while the jury is still out on the second "kiss." Will the second "kiss" get the cheese or the prize?

This may be at the mother of all inflection points. Either the market could extend from here substantially in time and price or it's headed meaningfully lower. And by substantially higher, as you know, I'm not referring to the possibility of a tag and inverse head-and-shoulders projection to 1250 S&P being satisfied going into January. This could play out and still be an overthrow of this live angle. Substantial, in this case, refers to a revisit of the prior all-time highs. This period here in November and then again in January will give us indications as to which way the pendulum will swing.