Is The Dollar In The Driver's Seat?

08/15/08 4:05 PM EST

As of: SPX 1251 HELP  ARCHIVE

This morning we went over the idea that option expirations have an undeserved reputation for being volatile days, when in fact they tend to be just the opposite, rarely showing large directional moves either way.  Today is helping to confirm that behavior, as we had to endure the kind of choppy trading we should expect more of over the next two vacation-infested weeks.

Crude Oil finished lower again today, helping to give a boost to equities.  Even a late-day spike didn't derail the weak rally in stocks, something it has been prone to do lately.

The table below shows several different assets and/or sectors, along with their correlation to the S&P 500 since the July 15th low.  Correlations can theoretically range from a perfect +1.0, where both assets move hand-in-hand, to -1.0 where they move exactly opposite each other.  To get the correlations, daily closing changes were used.

The highest correlation among them all was the BKX Banking Index, which has had an exceptionally large influence on the S&P as worries over the banking system jerk the broader market around on a daily basis.  Next to that, the largest influence was the movement in the U.S. Dollar, with a 0.6 correlation, followed by spreads on investment-grade corporate debt (as spreads increase, stocks tend to go down).

Oil and commodities in general had a lesser, but still high, negative correlation to the S&P, which is also partly already reflected in the Dollar.

A single snapshot can be useful, but it's better if we can get a longer-term view of how these correlations have been changing.  The chart below shows each of the correlations since the beginning of the year, on a 21-day rolling basis.

The correlation to the Banking sector has been very high the entire year, though since the July low it has moved from 0.6 to 0.8 as concerns about financials have taken center stage.

Interestingly, the S&P's inverse correlation to Oil (and commodities in general) and credit spreads reached its peak before the July low.  In mid-July, the highest correlation among all of them was the S&P's inverse reaction to Oil, which is still negative but quite a bit less than it was a month ago.  So while we may hear a lot about how Oil is driving the equity market, we should realize that while there is likely some truth to that, it's less of a factor than it was a month ago, and indeed financials and perhaps even the Dollar are more of a driving influence now.

We can't necessarily infer that movements in these other markets cause movement in the S&P, but it's a pretty good bet that to some degree they do.  This suggests that we should continue to watch sentiment in those other assets to get a handle on where the S&P may most likely be headed.

According to the latest Commitments of Traders report, the Dollar has become quite a focus of speculators.  Both large and small specs have moved to an extremely aggressive net long position in the currency, as you can see from the chart on the site.  This is close to their largest exposure to the Dollar ever; the only other time they reached more of an excess was in June and October 2005.

We're also seeing renewed enthusiasm in our Public Opinion towards the Dollar, and in the huge inflows to the Strong Dollar fund at the Rydex mutual fund family.  If these indicators work in their typical contrary fashion, then it should mean some trouble nearby for the Dollar, and according to the correlations above that may help to translate into trouble for the stock market as well.

It's always a little dangerous (sometimes a lot dangerous) to read too much into inter-market correlations since they are always evolving, but we can see from the chart above that the Dollar's positive correlation with the S&P has been strongly positive - and growing - for the past couple of months and so far doesn't seem to be changing.

Among our other equity-specific indicators, not much changed today with the choppy market.  We got a narrow-range day on what looks to be light volume, which is most often a short-term negative going forward.  As we've discussed the past couple of days, the last two weeks of August are almost always some of the lowest-volume ones of the entire year, but option expiration days tend to have higher-than-average volume so it seems to be starting early.

Most of our other sentiment-, breadth- and price-based indicators are neutral or cancelling out opposite extremes, so I continue to do very little trading-wise here until we get a better setup with more extremes one way or the other.  I'm still holding a core based of intermediate-term longs based on what we went over on July 15th and in the subsequent days, and so far have not seen much to get me to want to change that.

Have a safe and relaxing weekend and we'll see you next week!

Expiration Ushers In Vacation Time

08/15/08 9:25 AM EST

Good Friday morning...We begin the day with flat pre-market futures as we endure the last option expiration before seemingly everyone scoots away on vacation.  Commodities are getting hit hard and foreign markets are mixed to slightly positive.

Option expirations have a reputation for being wild affairs, but in reality they tend to have a smaller range than non-expiration days.  One thing we typically don't want to see on an expiration day is a gap up opening, though, since they tend to invite sellers more than buyers.  We're seeing that this morning, though the gap has shrunk the closer to the open we get.

Over the history of the S&P 500 tracking fund, SPY, it has gapped up on the morning of an option expiration 82 times, and finished the day higher than the close only 41% of the time, averaging a return of -0.2%.  8 of the last 9 instances, dating back to last June, have led to negative performance after a gap up open.

We usually see a negative hangover on the day following an option expiration, but that has not at all been consistent during prior Augusts.  In fact, there is a small spurt of positive seasonality early next week, but after that I see no seasonal bias until right before Labor Day (which, as usual, tends to show a rally immediately before the holiday and weaker performance afterwards).

I mentioned yesterday that after today, we will almost certainly see volume drop off precipitously as traders take the last of their vacations before the school year.  That doesn't necessarily translate to lower daily ranges, though, so we should still see some movement in the next couple of weeks.  It will probably be quite "whippy", particularly in the middle hours of the day.

As for the short-term, our most sensitive guides are mixed after yesterday's rally from oversold conditions.  The rally yesterday morning was enough to push the Price Oscillators for the S&P and NDX into overbought territory, but the afternoon chop alleviated that.  A quick look at the Indicators At Extremes section of the Daily Overview page, or a scroll through the bull/bear icons on the Complete List of indicators will quickly show that we have a lot of neutral indicators, and a mix of others at opposite extremes, mostly cancelling each other out.

Sentiment doesn't usually do us much good unless it's at an extreme, and right now we're not seeing that on any time frame.  The studies we went over on July 15th and over the next week suggested a one- to three-month bounce, and with us approaching the lower end of that we should start seeing some studies hinting at an end to the rally but so far I have not been able to find any.

With likely choppy trading ahead, an upcoming lull in volume, a lack of extremes among our sentiment and breadth indicators, and no consistent predictive price patterns that I can find, I'm not doing anything here trading-wise.  I'm holding some intermediate-term longs that I've left unchanged for about a month, and other than that I'm being pretty inactive until a better setup emerges.