A rising dollar has spelled trouble for stocks for much of the 21st century. Right now the US dollar is sitting right above important long-term support. The odds of a dollar rally are above average. Does that mean lower stock prices? Here’s a detailed look at the correlation between the dollar and stocks.
Everybody (including me) is trying to get a handle on the market they follow, but not ‘all roads lead to Rome’ when it comes to market forecasting.
Some roads (aka market forecasting approaches) are simply dead ends.
Correlations between asset classes and currencies are a legitimate tool to estimate future moves.
One of those relationships is the correlation between stocks and the US dollar.
Theoretically a falling dollar is good for US stocks. Why? A falling dollar makes US products cheaper in foreign countries, which in turn is good for US profits and stocks.
Does the theory hold up in real life?
Obviously, the correlation is an inverse one and somewhat difficult for the untrained eye to detect.
The second chart plots the S&P 500 (NYSEArca: SPY) against an inverted UUP. This makes the correlation a bit more apparent. In fact, comparing the S&P 500 (NYSEArca: IVV) to the inverse dollar is almost like comparing it to the euro (NYSEArca: FXE).
The correlation held up for much of July 2008 to November 2011. What happened in November 2011? Operation Twist was reintroduced, but I’m not sure if that’s enough to upset the correlation.
Regardless of the cause, since November 2011 investors haven’t been able to count on the US dollar/stock correlation to predict future moves for either stocks or the dollar.
Still, it is interesting to note that the dollar is close to important long-term support with above average odds of rallying from here. The red boxes in the first chart shows that recent dollar rallies usually turned into speed bumps for stocks.
So, there’s reason in not ignoring the dollars effect on stocks entirely.
Simon Maierhofer is the publisher of the Profit Radar Report.
Follow Simon on Twitter @ iSPYETF