Don't Short Stocks and the Dollar Just Yet

by Andrea Kramer |

Published on May 18, 2017 at 1:55 PM
Updated on May 19, 2017 at 3:47 PM

The major stock market indexes could be headed for short-term gains

The greenback could be headed for a short-term bounce, if past is prologue

Stocks took a beating yesterday, as the latest controversy surrounding President Donald Trump fueled concerns that his legislative agenda could be derailed. As such, the major stock market indexes suffered their worst session in months, and the U.S. dollar erased its post-election gains. Against this backdrop, we're going to take a look at how the Dow Jones Industrial Average (DJIA), S&P 500 Index (SPX), and Nasdaq Composite (COMP) tend to fare after these steep one-day slides, and analyze the oversold signal sounding on the PowerShares DB US Dollar Index Bullish Fund (UUP).

The Dow and S&P both suffered 1.8% losses yesterday, marking their worst one-day percentage drops since Sept. 9. Meanwhile, the Nasdaq gave up a cool 2.6% -- its worst session since the Brexit backlash on June 24. However, according to data from Schaeffer's Senior Quantitative Analyst Rocky White, pullbacks of such magnitude tend to precede outperformance for the indexes.

Dow After Drops of 1.5% or More

Since 2010, the Dow has given up 1.5% or more in a day just 84 other times. The session after, the Dow was higher 59.5% of the time, with an average return of 0.14% -- that's better than its average anytime one-day return, going back to 2010, and today we're on pace for a modest rebound. One week after these steep pullbacks, the DJIA was up 0.78%, on average -- more than five times its average one-week gain.

It's the same story looking two weeks and one month after a big drop, with the Dow notably outperforming its anytime returns. In fact, a month after declines of 1.5% or more, the DJIA averaged a gain of 2.02%, and was higher 72.6% of the time. For comparison, the Dow's one-month anytime return is just 0.81%, with a positive rate of 65%.

Dow chart after big drops

SPX Outperforms After Steep Losses

The S&P has suffered 101 single-day drops of 1.5% or more since 2010, and like the Dow, the index tends to outperform in the short term. A day after these massacres, the S&P averaged a gain of 0.19% -- about four times the norm -- and was higher 62.4% of the time. Going out one month, the SPX averaged a 1.5% recovery, with a positive rate of 67.3%. That's compared to an anytime one-month return of 0.94%, with 65.9% positive.

SPX chart after big drops

Nasdaq Could Stage Strong Rebound, If History Repeats

The Nasdaq has dropped 2.5% or more in one day just 37 other times since 2010. The index historically tends to underperform the next day, too, with an average loss of 0.11%, and a positive rate below 50%. That's compared to an average one-day gain of 0.06%, going back to 2010. 

However, beyond that, outperformance is the name of the game for the COMP. A week after these steep declines, the Nasdaq was up 1.53%, on average -- a whopping five times its average one-week return. Plus, the index was in the black more than 70% of the time. Looking out two weeks, the average post-signal gain of 1.52% is nearly three times the norm. And while the Nasdaq's positive rate of 64.9% one month after a drop is slightly less than normal, its average return of 2% is much better than its anytime one-month gain of 1.23%.

nasdaq after big drops

Dollar ETF Breaches Key Levels

As alluded to earlier, concerns about the drama in Washington, D.C., have weighed on the U.S. dollar, too. On Monday, the PowerShares DB US Dollar Index Bullish Fund -- which tracks the dollar relative to a basket of six major currencies -- gapped lower, and yesterday touched its lowest point since early November. The UUP also fell beneath the $25.50 area, which is a roughly 50% Fibonacci retracement of its rally from May 2016 to its all-time peak of $26.83 in January. What really caught our attention, though, was the exchange-traded fund's (ETF) breach of its lower Bollinger Band (BB) -- often an oversold signal.

uup etf chart may 18


Since 2010, the UUP has closed beneath its lower BB just 39 times, according to White. However, like the Dow, S&P, and Nasdaq, the greenback tends to recover nicely in the short term. One week after a breach of its lower BB, UUP was up 0.35%, on average, and was higher two-thirds of the time. That's almost eight times UUP's average one-week return of 0.04%, going back to 2010. It's the same story looking out three months after one of these signals, with higher-than-average returns and a better positive rate across the board.

dollar etf after bb break


Perhaps the recent dollar weakness -- and likely the relief rally in the wake of the recent French election -- is why many speculators are flocking to the euro. The latest Commitment of Traders (CoT) data shows that large speculators are now long on the euro for the first time since 2014. Further, while UUP shares have surrendered 4.6% in 2017, the SPDR Euro Stoxx 50 ETF (FEZ) is up 16.5% and touched an annual high of $39.83 earlier this week.

Should Stock Traders Buy the Dip?

Nevertheless, if recent history is any indicator, the U.S. dollar, as well as the Dow, SPX, and Nasdaq Composite, could be headed for short-term gains. Traders betting on past being prologue would be wise to consider buying the dip. And for those still hesitant, as Schaeffer's Senior V.P. of Research Todd Salamone recently noted, "call options present an excellent way to leverage the longer-term uptrend in the market in lieu of stock positions that tie up more capital."



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