That’s what I noticed today as the dollar index fell 0.59% (that’s big in the currency world).

It’s a big deal because a falling dollar has usually led to gains in equities. But this time the market ended the day mixed. The Dow Jones was up 0.43% and the S&P climbed 0.23%. The Nasdaq stuck out like a sore thumb, falling 0.21%. It seems that the old dollar/stock market pattern isn’t holding up as well as it used to.

This indicates to me that the dollar carry trade is losing some of its luster. In the end, these ultra-low interest rates probably won’t last forever.  I expect the dollar carry trade to be replaced with the Yen carry trade (since Japan apparently doesn’t believe in higher interest rates). The new Bank of Japan governor has also shown a preference for a weaker currency. So moving forward, we should see a big correlation between the Yen and the US stock market.

As you can expect from a falling buck, gold was on the up and up, gaining $14 to close at $1,151 an ounce.

Honestly, though, I wouldn’t read too much into a falling dollar. The market has been data driven as of late. Investors are all looking for signs that the recession is truly over. And as long as this week’s reports show an improving economy, the market could head higher, taking the US dollar along for the ride.

The report I’m most interested in is the December Consumer Price Index report this Friday. This report measures inflation at the consumer level. If this report shows a big bump in consumer prices, the market could easily sell-off. That’s because higher inflation means the Fed is more likely to boost interest rates.

And higher interest rates signal an end to cheap money.

Will the CPI come in very high? I doubt it. Gas prices were close to flat in December. And at the same time, retailers were discounting everything. So I wouldn’t be shocked if CPI came in at or under consensus (0.0%-0.1% gain).

At this point I’m cautiously bullish, especially on the commodity complex.

The reason why the indexes didn’t move much had to do with economic news. The Commerce Department reported factory orders for November that were twice as good as what had been expected. This good news was offset by data that the National Association of Realtor’s Index of Pending Home Sales dropped 16%. That was the first drop in nine months.

Plus, dollar started trending higher again, moving up almost 1%. Not only did this put pressure on the stock market, but it also helped push down the price of spot gold by 3.35%.

When you look at the technicals, the market is pretty overbought. Don’t get me wrong, if the technicals were overbought and everyone hated the market, I’d probably take it as a sign of higher prices. But right now everybody is bullish.

The American Association of Individual Investors Bullish Ratio hit its highest level since February of 2007. The market topped out later that year.

Another sentiment indicator, the Investors Intelligence Advisors’ Survey (they all sound the same), showed the lowest percentage of bears since March of 1987. We all know what happened a few months later…

So, while investors can stay bullish for a long time, the contrarian in me says that we’ll see a drop in the next 3-6 months. But that’s not the only reason why i think we’ll see a drop in the second half of the year.

During a typical recovery, the inventory rebuild leads to more jobs, which leads to more domestic consumption, which finally starts a growth cycle. But right now, consumers are up to their ears in debt. Most have been laid off. And a good number have seen their hours cut. People out there are picking and choosing what bill to pay. And the credit card ends up being the last one.

Consumer demand can’t take off in that type of environment. Cash is tight. And the next dollar is used to pay the next bill.

To make matters worse, the Fed may end up tightening in response to this inventory rebuild and the effects of the stimulus. Could the Fed be so stupid? Sure they could!

Listen, the Fed typically begins tightening as soon as job growth begins. Over the next 12 months, the US government will hire up to 1.4 million people for the 2010 census. And even though these 1.4 million jobs will probably only last about 6 months, it could definitely push the labor market up over the next few months.

It’s enough to make you go “hmmm”.

An overbought market with record bullishness… poor consumers… and tighter money, spells a recipe for a nasty second half.

The Dow Jones, Nasdaq, and S&P all broke under the 20-day moving average. The 50-day is in the line of sight. Will all three indexes plunge below the 50-day? I may not have a crystal ball, but I do have technical analysis.

Dow Jones Industrial Average

This is what the chart is telling me right now

• The Dow Jones saw significant resistance at 10,500. It even tried six times to break above 10,500 with no success.
• Huge spike in buying volume followed by selling might indicate a blow-off top.
• The RSI and Slow Stochastic are both in neutral territory. This signals more downside left (I’d like to see these two oversold before buying).
• The Dow broke under its 20-day average but is still above its 50-day.

It looks like we might have a few more days of selling. But I expect buyers to come back in as soon as the major averages hit their 50-day moving averages. If we see a decisive break UNDER this average, it could signal a change in trend.

In other words, buying now might be a bit silly. But getting heavily short right now is equally as silly. It’s kind of like betting against the Yankee’s in the first inning because the Red Sox barely hit a home run. It’s just too soon to make that bet.

In times like these, you want to use these small downturns to hedge your portfolio.

Yesterday I recommended you get into January VIX out of the money call options to hedge your portfolio. If you had done what I said, you would probably be in the green (the VIX is up over 6% today!).

Until the trend becomes bearish, I simply won’t get heavily short this market. And that won’t happen until the 50-day is breached on all three indexes.

In a speech Ben gave today, he told us what we already knew: that the US expansion would be slow and that there were significant headwinds ahead. Why this shocked the market into a decline is anyone’s guess. After all, the market is supposed to be efficient. And it should have priced this in already.

It obviously didn’t (another loss for the efficient market corner).

You can get a transcript of Ben’s talk here: http://www.ritholtz.com/blog/2009/12/chairman-ben-s-bernankes-frequently-asked-questions/

In the meantime, we have to determine what this means to the stock market and most importantly, to our own portfolio.

With Ben saying that inflation will drop, investors got out of risk (commodities, emerging markets, and US stocks) and into treasuries and the dollar. The yield on two-year treasuries alone dropped 7 basis points today (0.07%) and the buck rose 0.3% against the Euro.

This, of course, is the second straight day of dollar gains (Read Friday’s post to see what I said about it then). And if you’ve followed my writing for some time, you know that I’m expecting a dollar rally in the next few months. But whether what we’re seeing today will transpire into the dollar rally I’m looking for isn’t clear.

The Dow, S&P, and Nasdaq are all above the 20-day moving average. If that support line fails, I expect to see support at the 50-day averages. If we see the markets penetrate the 50-day, then i’ll take my ramming bull horns off and put on a stinky bear outfit and go hibernate.

If you’re heavily long, you should probably put on a little hedge by buying an out of the money January call option on the VIX.