It was a mixed session yesterday as the U.S. dollar firmed slightly with gold, copper, and crude oil prices declining. Late in the day the outflow of money away from the U.S. equity markets appeared to abate somewhat following the conclusion of the Federal Reserve Open Market Committee meeting.

Jan. 27 (Bloomberg) — U.S. stocks rose as the Federal Reserve pledged to keep interest rates low, while global equities fell for a sixth day and Greek bond yields surged amid concern growing sovereign debt will derail the economic recovery. Oil fell to a five-week low.

Below is a chart that we have been running on a daily basis in the back pages for quite some time. The chart compares the U.S. Dollar Index (DXY) futures with the ultrabearish FTSE Xinhua China 25 etf (FXP), and the ratio between the Philadelphia Semiconductor Index (SOX) divided by copper futures prices.

In a sense this chart explains much of what has been going on in the markets and, hopefully, quite a bit with regard to what will happen in the future.

The argument is that a stronger dollar goes with some amount of downward pressure in Chinese equities. The FXP rises when China’s shares market declines.

The SOX/copper ratio represents the relative strength of two different cyclical themes- tech and base metals. As we have explained on far too many occasions the tech sector tends to outperform when capital is moving towards the dollar while base metals prices do better when the dollar is weaker.

One of our recurring arguments has been that if the dollar rises and the tech sector holds flat or declines then the broad market has almost nowhere to go but down. We were encouraged yesterday by strength in both the banks and the semiconductors in response to dollar strength because this represents a potential bullish outcome in response to weakening commodity prices.

Equity/Bond Markets

Below is a comparative view of crude oil futures and the ratio between the Amex Oil Index (XOI) and S&P 500 Index (SPX).

We have done this argument many times over the past few years but because it is both important and timely... we are going to run through quickly once again today.

There are any number of ways for the markets to recover but chief among the possible options are ‘stronger energy prices’ and ‘weaker energy prices’. The strong energy price theme helped power the markets higher from 2004 into 2008.

We have argued that similar to post-1990 we can get a bullish outcome from energy price weakness. In other words if money gradually rotates away from the major oils (XOI) towards other sectors the entire market can lift in price.

Below we show the XOI/SPX ratio along with the share prices of  Carnival (CCL) and Wells Fargo (WFC).

The chart shows that once the XOI/SPX ratio peaked in March of last year the share prices of CCL and WFC began to lift. The problem of late has been that the XOI/SPX ratio has held above the lows set in August which has essentially stalled the recovery for some of the non-commodity sectors. Ideally we continue to get enough downward pressure on crude oil prices to push the XOI/SPX ratio through the lows set in August and December last year. Our thesis is that this will lead to a push to new recovery highs for energy users such as CCL and major financials like WFC.

On a short-term basis WFC is trading every other day as if it is going to bust to the upside or collapse back to the down side. The chart below shows that the share price has been making fairly wide daily swings even as it ‘flags’ back towards the moving average lines. Something north of 29.50 would be encouraging especially if CCL was working through 35 at the same time as the XOI/SPX ratio moved down through .94.