A Higher Dollar Will Suggest Reversal Risk in S&P 500

NEW YORK (BestCredit.net) --  The SPDR S&P 500 Trust ETF (SPY) is now trading in mostly uncharted territory above 180, tracking activity in the S&P, which is higher now by roughly 29% for the year (on pace for the largest biggest annual gain since 1998). But while the broad momentum is clearly aimed in the bullish direction, profit-taking in liquidity-thinned markets and the performances seen in inversely correlated markets suggest that we will likely see some downside corrections in the major stock benchmarks heading into next year. At this stage, downside risk clearly outweighs upside potential, so while I do not expect an outright reversal in SPY, caution is warranted and it clearly makes sense to start trimming back on positions at current levels.

SPY and Inversely Correlated Assets

So, the next real question is when this optimism will start to pullback and give market prices a needed bearish correction. Upside strength in the SPDR S&P 500 Trust ETF has been undeniable, as investors start to deal with holiday-thinned trading conditions. There will be added incentive to book profits and wait for better entry levels into 2014. In addition to this, we have some cautionary signals that are currently being exhibited by inversely correlated assets and potential reasons for stronger-than-expected GDP performances in the fourth quarter that could lead large sections of the market to anticipate additional QE tapering at the U.S. Federal Reserve.

Bullish performances in the U.S. dollar tend to be seen when markets are in risk-averse modes, so the upside surges in the greenback should send some warning signals to investors watching inversely correlated assets. Since the strength of the upside momentum in SPY is so clear, it will be important to watch price activity if we are able to trade back into 177.95. This is an area of "resistance turned support," so if investors are unable to hold prices above this region, we could start to see some deeper pullbacks as markets prepare for lower-volume trading conditions.

Price Perspective in the Dollar ETFs

But with the Dollar Index now pushing against its November highs, it will also be important to watch activity in the PowerShares DB US Dollar Index Bullish ETF (UUP), as any major rallies here could be an early indication of what will be seen next in SPY and the S&P 500. We have already seen clear evidence of major trend reversals in the Dollar ETFs, so it will be critical for stock traders to monitor market activity as UUP tests 21.40. Any upside breaks here will suggest that further gains are in store and this will likely give pause for some sections of the market looking to establish new SPY longs at their elevated levels.


This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

Sam Kikla is the founder of BestCredit.net, which offers the latest information in consumer trends, debt management and labor markets as they relate to the broader market environment. Focus is placed on investment decisions that are affected by consumer trends, and credit markets are addressed from the long-term perspective, with most of the attention paid to macro events influencing multi-year market positions.

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