The eye-catching rally of the Dow Jones Industrials over the past 12 months looks good, but when viewed through the lens of currency weakness, the market may be flashing warning signs that a key reversal is nigh, according to one trader.
Glance at a chart of the Dow in US dollars, and then compare that same chart priced in South African rand and it is easy to draw conflicting conclusions about the strength of the US recovery, says Sol Palha, senior analyst with New York market advisory Tactical Investor.
The dollar-denominated Dow chart reveals a powerful nine-month rally from the 7,400 low in March to a two-year high last week, just above 10,500. Powerful evidence of a sustained recovery? Not so, according to Mr Palha, who says the same index denominated in rand shows a market that has meandered sideways for most of the year, caught in a tight trading range little higher than its March lows.
'If you price the chart in US dollars the chart looks really beautiful. I mean the pattern looks remarkably bullish. You could be fooled into thinking we are in a super bull market,' Mr Palha says. 'However, if you price this in rand it shows that the Dow is basically flat and moving sideways.'
While sceptics could argue the appreciation of the rand may be an aberration, Mr Palha says similar results could be obtained by converting the charts a number of strong currencies that have outperformed against the dollar in the past year.
What is really driving the Dow rally, Mr Palha says, is monetary inflation. Take into account the declining exchange value of the US dollar and the market appears nowhere near its former highs.