Watch this signal to see if the rally can continue, strategist says

What was notable about Monday’s action in U.S. stock markets wasn’t so much the move — a modest 0.2% drop for the S&P 500 SPX — but the sector composition. Energy SP500.10, real estate SP500.60 financials SP500.40, and materials SP500.15, the sectors beaten up by the COVID-19 pandemic but gaining ground on the good vaccine news, led the downturn as California introduced new COVID-19 rules, while safer utilities SP500.55, 0.21% and technology companies SP500.45 advanced.

Thomas Lee, the head of research at Fundstrat Global Advisers, isn’t giving up on the rally. Even with a surge in COVID-19 cases in the U.S. and new restrictions popping up, there are three financial market barometers that are suggesting that the trend toward risky assets remains in place. The dollar DXY is weaker, credit (particularly high-yield HYG ) is rallying, and the VIX volatility index VIX is “behaving,” he says

The dollar, says Lee, is what’s key. There could have been four factors to boost the dollar — the surge in COVID-19 cases, weak economic data, presidential transition risk, and vaccine supply issues. “So these things, if raising risk of an economic relapse, should be causing USD strength. Instead, we see a steady decline in USD,” Lee says.

As long as the dollar is weakening — and Lee says a technical analysis shows it should be declining for the next three to four years — there is further equity upside. “This is not that different from the USD story in 2017 through mid-2018, or 18 months. During that time, S&P 500 posted a strong 2017 and was strong into 3Q18 (up ~8%),” he says. “But once USD started to strengthen (along with Fed tightening) = 4Q2018 was a train wreck.”

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