The dollar's big counter trend rally

Key points:

• Over the past month, the U.S. dollar has jumped more than 3%
• That comes on the heels of what had been a 9-month low
• Similar rallies in the dollar showed a strong tendency to fail, with positive implications for other markets

Strong counter-trend rallies in the dollar tend to fail

Investors have had a renewed focus on the U.S. dollar in recent weeks, which has helped to upend some trends in place since October.

The dollar has enjoyed a strong rebound over the past several weeks, with a 21-day rate of change of more than 3%. The rally is coming on the heels of at least a 9-month low in the dollar, but not a 2-year low. Meaning, it has been a counter-trend rally that was not within a prolonged downtrend.

After similar rebounds, the dollar struggled to hold its gains. It sported a negative return after all but one signal either one or two months later. The only exception was in 1992; that rally petered out in the months ahead.

A dollar counter-trend rally's impact on other markets

For the S&P 500, the failure of the dollar to follow through on its counter-trend rallies was a good sign. Over the next 3-12 months, there were no losses of any magnitude, and a year later, the index sported a positive return every time. The maximum gain within the next year averaged more than five times the average drawdown.

Technology, Financials, REITs, and Industrials enjoyed the strongest returns among sectors and factors.

There were two fewer signals for Emerging Market stocks due to limited data. Over the next three months, all signals showed a positive return, though two of those fell hard in the months ahead.

If the dollar struggles, that usually means good things for gold. While there were some losses, gold rallied over the next few months after 7 of the 9 signals. For the most part, gold did quite well, with mostly limited losses and potentially substantial gains.

Commodities, in general, also tended to rebound, though it was primarily loaded in the short term.

What the research tells us...

In recent weeks, many trends in place across markets since October have reversed. Some of that has been driven by a rebounding U.S. dollar, which has a powerful impact on commodities and overseas returns. However, the type of rally the dollar has enjoyed appears to be counter-trend. Similar patterns had a strong tendency to reverse once again, leading to negative returns for the dollar and positive ones for most other markets.