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  • Stocks and commodities have rallied, and the Dollar has retreated.
  • The Dollar may rebound, pressuring commodities lower in the short term.
  • The S&P 500 is challenging its 200-day moving average, and it faces stiff resistance at the top end of its trading range. 

The rally in stocks and commodities may take a breather. Bearish positioning, bargain hunting, a weaker Dollar, decelerating inflation, and hopes for a friendlier Fed have contributed to a stunner of a start to the year. However, stocks don’t go up or down in a straight line, and there’s good reason to think that mean reversion is likely.

Active investors with a shorter time horizon may want to take advantage by putting some profit in their pockets.

The Dollar is key

The U.S. Dollar broke out to new highs in June. Then, it rallied significantly into October, contributing to a widespread sell-off in commodities, including crude oil and gold, because they’re priced in Dollars globally and negatively correlated.

A strong Dollar also contributed to a sell-off in multinationals, particularly technology stocks, which rely highly on sales overseas. Converting foreign sales into Dollars substantially lowered top-line growth, particularly for big-cap technology companies. For example, absent currency exchange headwinds, revenue at Microsoft  (MSFT)  would have increased 16% year over year rather than 11% last quarter.

The Dollar rally, however, stalled in October because decelerating inflation boosted optimism that the worst of the Federal Reserve’s interest rate hikes were behind us. Commodities and stocks have benefited as models were adjusted to reflect ongoing Dollar weakness.

West Texas Crude is up 14% from December’s low. The GOLD ETF  (GLD)  has rebounded from 2022’s lows, rallying nearly 18% since early November. Likewise, stocks have marched higher from their October lows. The S&P 500  (SPY) , Russell 2000 Small Cap  (IWM) , and SP 400 Mid Cap  (MDY)  ETFs are up 13.5%, 14.2%, and 17%, respectively.

A short-term Dollar rebound?

The Dollar’s primary trend is down, but assets don’t move up or down in a straight line. As a result, you can have secondary movements within a primary trend, creating opportunities to adjust long or short exposure.

In this case, the Dollar Index's rapid descent has brought it back to levels last seen in the second quarter of 2022. A relief rally to its declining moving averages wouldn't be surprising.

Real Money Pro commodity expert Carley Garner accurately forecast the Dollar’s slide. What’s she thinking now? Garner believes the Dollar will continue falling but that a short-term bounce is increasingly likely. She writes, “The dollar trajectory is decisively lower, but we wouldn't be surprised to see a big bounce in the short run. We continue to believe the Dollar is headed into the high 90s, but the bounce from here can be big. Greenback bears should be prepared for a shakeout.”

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Correspondingly, assets negatively correlated with the Dollar could be about to give up some recent gains, including Gold. Garner writes, “I'm not saying I believe gold has hit the high for the year (two weeks in), but I am saying there is a good chance we get a hard and healthy correction. Not everyone wants to hear this, but the gold rally is out of bounds. A pullback to $1830, or even $1800, would be healthy.”

Stocks are due for a pullback

The recent stock market rally has lifted the S&P 500 to critical resistance at the 200-day moving average. At the same time, the index is also closing in on the high end of the trading range established by Real Money Pro’s Doug Kass.

In his daily trading diary on Real Money Pro, Kass wrote today, “S&P cash is now at 4005 -- that represents only +95 handles of reward vs. -305 handles of risk -- relative to my projected trading range. Accordingly, I am selling some longer-dated (September) (SPY) and (QQQ) calls short.”

Kass has been modeling an S&P 500 trading range of 3700 to 4100 for months. He bought stocks when they flirted with the low end of his range in December. Now? Kass sees too little reward to press long-side bets, so he’s reining in exposure to profit from backfilling the recent move higher.

He explained his short-term bearish thesis this morning, writing:

“* After having taken a non-consensus view in accumulating stocks on weakness in December, I have been selling strength more aggressively over the last week.

* The market has rallied on the basis that inflation is falling more rapidly than growth expectations. Though the thrust in breadth has been powerful, we have reached an overbought reading and approaching levels vs. my expected trading range that indicate an unattractive reward compared to risk.

* In the last two weeks, we have seen an abrupt change of sentiment as price has a way of changing it! The S&P Oscillator is back up to 9.18%. In contrast, when the rally started, the Oscillator was deeply was oversold at negative 5.35%.

* Meme stocks and FOMO are back -- gewgaws are another worrisome sign of speculation. These factors might continue for a bit longer, but history shows it will be relatively short-lived and that it won't likely be a permanent condition. This is particularly true with the defensive positioning on the part of CTAs, retail, and hedge fund communities.

The Smart Play

If you made a lot of money in energy stocks, this could be a good spot to lock in some profit. The exploration and production segment saw robust year-over-year revenue and earnings growth in 2022. However, tailwinds will ease as we anniversary last year’s crude oil price spike, resulting in tougher year-over-year comparisons.

To maintain growth rates amid lower year-over-year crude prices, producers will increase spending to boost production, supporting energy service stocks, such as Schlumberger, and drillers, such as offshore Goliath Transocean Offshore  (RIG) . We’ll get insight into utilization trends for services plays later this week when Schlumberger  (SLB)  reports its quarterly earnings.

If I’m correct, investors should take profit from producers and seek to redeploy some proceeds into services stocks on weakness.

Gold has had a big move higher, so Garner is on point to suggest some selling. If gold declines because of a short-term Dollar rally, precious metals stocks may lose some luster too. If so, look to re-enter them on retests of key moving averages. For example, Hecla Mining  (HL)  is one of Real Money technician Bruce Kamich’s favorite ideas. If the Dollar rallies to resistance, consider buying it on a successful test of its 21-day or 50-day moving average. As of this writing, that’s roughly $5.40 to $5.70, down 6% to 10% from current levels.

As for the indexes, the S&P 500’s at a critical juncture. On Friday, I explained how uncommonly widespread strength triggered just the 25th Breakaway Momentum breadth thrust since 1949 – a bullish event with a 96% win rate one year later. I also noted, however, that these thrusts, by their nature, occur alongside overbought readings. As Kass points out, the McLellan Oscillator (and the short-term oscillator favored by Top Stocks’ Helene Meisler) is flashing overbought.

Given that breadth thrusts in 2009 and 2020 were followed shortly by selloffs before a more sustained uptrend, it wouldn’t be surprising to see stocks travel a similar path this time. If so, sellers may try to knock some of the air out of stocks. How much air? Well, that will depend on how quickly shorts use a selloff to cover positions (some were likely trapped in the recent rally) and if there’s enough FOMO to prompt bargain hunters who missed the rally to click the buy button into weakness.

In the meantime, if you’re an active trader, play some defense until we get more clarity. 

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