A student of mine (if I may be so bold to call him one of mine!) has been using many of my favorite indicators to predict the turns in the markets. Today, he pointed out that the McClellan Oscillator (NYMO) was down- crossing zero which can often lead to strong  in changes in the direction of the markets. I agreed with him as for a short term interpretation….and the Summation Index (NYSI) takes accumulations of these readings, as he  seems to know. So, a consistently negative NYMO reading is going to make NYSI more negative…and vice versa.

But to make his charting more complete, I challenged him to  step back and look at the fundamentals! I believe the best chartists still keep the fundamentals in perspective, only if to validate what they are seeing on their charts.

If I may draw a quick comparison here: you have surely heard the old saying among IT professionals that the results one gets out of their computer programs is only as good as the data one feeds into their computer programs. In other words, the old adage “Garbage in, Garbage out!” (or “GIGO”) is something to think about.

To this end, let’s think about his statement today in which he said:

“With this, the USD reversal and heavy selling of oil and other resources, I feel the top has been set.”

So I ask him why he feels this to be the case? Is it because his charts tell him this in a convincing way? I ask that he pause for a moment and think about the other old adage which is “statistics don’t lie, but people do!” Since charts are based on statistics, we have to ask ourselves if it is our human mind that is interpreting what we see in chart form to be the correct interpretation?

Rather than put him on the spot (which is not my goal here!), I will go on to answer the questions I raise by attempting to give him (and my readers) another side to the stronger dollar scenario we now seem to have.

To do so, we have to look at the financial headlines of the past 24 hours.

…and in the news last night, we come to learn that the US Treasury Secy Geithner publicly declared that the US does not support a weak $ policy. Suddenly, the overnight currency markets tighten up as shorts race to cover off that statement.

Then, China surprises the world by raising interest rates 25 bp for the first time in 3 years. A higher interest rate, in theory, serves to slow down growth in China, which is further cause for concern among those who are riding the risk trade in commodities and gold.

OK, so this explains WHY the $ gained in strength over night. That’s all fine and good and matches up well with your chart interpreatations.

BUT NOW, I say let’s think if these two events will have a lasting effect on a $ reversal or will lead to more $ momentum.

Of course, they could…but my hunch is that the effect is short-lived, and this is where understanding the fundamentals and the strategic set-up could make this a short-lived phenomenon.

1) Treasury Secy Geithner says the US $ will be defended and we will not try to pay off our debt with cheap money! Well, hoo-ray and good, Mr. Geithner!

…but there is one BIG problem I have with your statement! YOU are not the one who controls the money supply nor the printing presses of the US! That job belongs to the FED which is headed by a fella (Bernanke) who insists the best way out of our predicament is to throw printed money out of helicopters into as many hands as possible! To wit, Mr. Bernanke through one of his FED governors announced yesterday that he plans to purchase $100 billion a month of Mr. Geithner’s treasury (debt) paper each month in a new round of Quant Easing! In other words, Mr. Geithner can no more defend the $ than could you or I. Anyone reading literally into the words of Mr. Geithner may discover that they have been temporarily duped!

2) China’s move to raise interest rates may well slow down the hot real estate market in China just a tad…and maybe slow down some buying of commodities and speculation in all things China? That is the intent!

Then again, there is the flip-side observation where higher interest rates in China help to attract more investment money from places that are de-valuing their currencies such as the US, Europe and Japan. In other words, higher interest rates in China (and a stable currency due to the peg to the $) fuels the dollar and Yen carry trades! What could happen is that after a short selloff period (the knee-jerk reaction you see now) could reverse as big money players decide that the 25 bp move is not very significant and that China’s 2.25% overnight interest rate creates a nice 225 bp profit center for them…this is known as the carry-trade. And for those who do not know exactly what the carry trade is, it is where BIG MONEY hedge funds and other big investors borrow in cheap dollars and Yen at ZERO percent interest and invest in those parts of the world that pay much higher returns. In China, a big hedge fund can borrow $$$ at 0% and invest in overnight Chinese govt bonds and earn 2.25% return at virtually NO risk!…or if the carry trade gets strength again, the hedge funds can then branch out further along the risk continuum and buy gold, silver, and tech stocks in places like China and other hot investment areas of the world.

My point being, is that having some knowledge of the economic backdrop and how it might play out makes the interpretation of the charts all the more interesting!

I do not read the charts as negatively as this follower does…I see an ADX that has barely changed on most of my major index charts. In many sectors, the 50 and 200 day lines are still quite supportive and rising.

I have to take the view, until otherwise shown, that today’s pullback is of a temporary nature. I believe that if one goes net short here and now, they may have jumped to conclusions too soon. IMHO!

Respectfully, ACE