kingworldnews.com
The US dollar has suffered a historic decline but here’s why the worst is yet to come.
July 18 (King World News) – Jason Goepfert at Sentiment Trader: The dollar suffers a historic decline and increasing pessimism.
Key points:
- Optimism on the U.S. dollar has faded, and sour sentiment tends to precede poor returns
- The dollar’s historic 5-day decline to a new low also tends to precede fragile returns
- Other assets, especially stocks, have benefitted from poor action in the dollar
Sentiment is souring on the dollar after historic decline
The U.S. dollar is losing ground quickly, and traders are giving up. For the first time in two years, the dollar’s Optimism Index has dropped below 40.
But
sentiment on trending assets like currencies and some commodities
doesn’t work as well as it does in a “bouncy” market like stocks. For
the most part, when sentiment is poor on a currency, it tends to keep
declining, and vice-versa. We can see that in the chart below – the
buck’s annualized return with an Optimism Index (Optix) below 40 was
-0.3%.
US Dollar Pessimism Increasing (Below 40) But Hasn’t Hit Bottom
During
strong uptrends, sentiment tends to get high and stay high. During
downtrends, pessimism is rampant, and the currency tends to sink. At
some point, sentiment becomes so extreme that the trend reverses, but
we’re far from that point now. That’s the general pattern with how
sentiment works, but it tends to be exacerbated for currencies, with
sentiment getting stuck at mediocre extremes for longer…
We
can see this another way in the equity curve lines below. It simply
buys and holds the dollar for the next trading day when the Optix is
above 60 (green line) or below 40 (red line). Over the past 32 years,
$10,000 grew to $12,435 when Optix was above 60 but fell to $7,702 when
Optix was below 40. Neither result is adequate for a trading program;
it’s just meant to show that using mediocre extremes as a mean-reversion
strategy was unsuccessful.
It’s
hard to blame dollar bulls for losing faith after a 5-day stretch that
was one of the worst in years. The dollar dropped more than 3% over five
days while skidding to its lowest level in over a year at the same
time.
US Dollar Had One Of Its Worst Weeks In History
Big declines tend to precede more losses
The combination of a historic one-week decline and a 52-week low has not
been kind to the buck. It rebounded over the next three months only 36%
of the time with more risk than reward. A few signals marked exhaustion
points, though two didn’t trigger until the dollar had already suffered
a multi-year decline.
US Dollar Mostly Red 12 Months After This Type Of Setup
Let’s
relax the parameters and look at 52-week lows, but with a one-week loss
that was the worst in at least six months. Using a 3% loss was too
strict based on the dollar’s relatively subdued volatility.
These
results were even worse. Over the next 2-12 weeks, the buck rallied
only 26% of the time, with risk about two to three times greater than
reward. Out of 19 precedents, only 2 showed gains across most time
frames. All the others were pretty consistent losers. Only four signals
managed more reward than risk over the next three months.
US DOLLAR:
Sea Of Red Everywhere After This Type Of Setup
Among
other assets, stocks tended to do quite well after the dollar suffered.
All the major indexes rallied well, with the most consistent gains in
the Nasdaq Composite and Russell 2000. It’s not shown in the table, but
since 1990, the MSCI Emerging Markets Index showed a median return of
+12.2% over the next three months with 9 winners out of 12 signals and
only one loss larger than -4%.
What the research tells us…
Sentiment on the U.S. dollar has soured thanks to a historic decline
over a recent one-week stretch. It’s not yet to the point that could be
considered extreme, and mediocre readings of pessimism in currencies
tend to lead to further declines. That has certainly been the case with
the dollar, as have significant declines to new lows. Other assets tend
to respond well to these big declines in the dollar, especially stocks
and (of course) other currencies. This is another example of why Jason Goepfert is the best in the world at what he does – providing actionable market data.
