As dollar rally flops, equities are reaching selloff points

The dollar rally fizzled out in the week to 20 January, giving global equities a boost but pushing them to levels where they previously sold off. The US and Indian equity indexes are at reversal points, putting bulls on notice.

Last week we had mentioned that both the US dollar and 10-year US treasuries were poised for a potential breakout and rally, which would have led to a selloff in equities. Both the asset classes are considered safe havens and rallies in them often lead to selloffs in equity.

However, both the dollar and treasuries broke their resistance levels and then sold off, leading to a rally in equities. But the fall in the dollar has pushed equity prices to key resistance levels. This is true of the Indian equity indexes - Sensex and Nifty - as well as the US equity indexes - the Dow and Nasdaq 100.

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[caption id=“attachment_189387” align=“alignleft” width=“380” caption=“The dollar rally fizzled out in the week to 20 January, giving global equities a boost but pushing them to levels where they previously sold off. AFP”]  [/caption]

Also, the fall in the dollar powered a copper rally to a previous selloff level. A selloff in copper is often followed by a selloff in equities. Before we look at the indexes, it is important to mention that a breakout from these levels can take prices higher and result in a further selloff in dollar and treasuries.

Indian markets: A look at the Nifty chart shows that the index has reached the level of a previous selloff in early December 2011. ( Click here for Nifty chart ). If the Nifty closes above 5, 100, it can rally higher. But till such time that happens, the bias is bearish. Also notice the candlestick the Nifty created last Friday. It is called a hanging man candlestick pattern, which is bearish.

The Sensex, too, has the same structure as the Nifty. It also created a hanging man on Friday. If the index closes about 17,000 it can rally higher. ( Click here for Sensex chart ). The indexes are at an excellent level to take short positions in anticipation of a selloff. However, if the Nifty rallies about 5, 100 and the Sensex about 17,000, one should get out of the short positions.

Entering at the current level with a stop-loss around the levels mentioned can lead to a small loss, but the profit potential is high. Given the risk to reward ratio, this is a good time to short.

US markets: A fall in US equities generally leads to a drop in the global markets. In the US, two of the four major indexes are at reversal points and they are the Dow and the Nasdaq 100. However, the S&P 500 and the Russell 2000 (small-cap index) have not hit reversal points.

The Dow neared the point of reversal hit in July 2011 ( Click here for the Dow chart ) and the Nasdaq 100 has already hit the level. ( Click here for Nasdaq 100 chart ). For the Dow, the reversal point is around 12,800 and a close above that can take the index higher. For the Nasdaq 100, that point is 2,450. The reversal levels are marked on the chart with a white horizontal line and white arrows.

If both these markets rally higher a lot of people will get bullish. But be careful as the S&P 500 is nearing its reversal level near 1,350. The index closed at 1, 315 on Friday. A fall in the S&P 500 can drag the other indexes down.

Copper: Copper hit its reversal level on Thursday and sold off on Friday. ( Click here for copper chart ) The reversal levels are marked on the chart with a white horizontal line and white arrows. In case copper falls, the equity markets tend to follow. So keep a close eye on copper to get a sense of direction for equities.

The dollar index sold off but is nearing a level from where it could bounce. A bounce will be additional confirmation for an equity selloff. In case the index falls below 79.50 it can go down further. The index closed at 80.22 on Friday.

Greece debt deal - a wild card: There is talk of a weekend deal between Greece and private sovereign bond holders. Under the deal, bond holders may take a 50 percent haircut(writedown) and extend the maturities. Some people calculate that the 50 percent haircut and maturity extension would erase the net present value of Greek bonds by as much as 75 percent. This is disastrous for the institutions holding the bonds, but the fact that there has been a deal could lead to a market rally.

George Albert is Editor, www.capturetrends.com