The dollar and the domestic stock market have been moving in opposite directions over the past couple of years. This relationship is clearly visible in the above 1-year chart.
However, lately there seems to have been some decoupling as the WSJ reports in “Dollar To Stocks: You Can Go Your Own Way?”
For much of the fall, after Fed chairman Ben Bernanke announced QE2, stocks rallied as the dollar sank in what felt like tit-for-tat mirror-image fashion, baffling a number of analysts and technicians. (We wrote about it here.)
Well, it’s over, some say.
More than one analyst has landed in our inbox, arguing that the autumnal dance between the U.S. dollar and the stock market has broken down with the wintry chills. As QE2 has receded into the back of investors’ minds, the dollar (DXY, the Dollar Index) and stocks (S&P; 500) have begun charting independent paths, with the negative correlation reverting to nearly zero, these analysts say.
The explanation, according to Macro Risk Advisors’ Dean Curnutt: the domestic economic recovery has strengthened, which helps both the dollar and stocks. And even though all signs seem to point to Chairman Bernanke following through on QE2 — further diluting the dollar’s strength — almost all of these expectations had been baked into the dollar’s price since the official $600 billion announcement in early November. “The fact that the SPX is able to ‘power through’ this decoupling seems pretty constructive,” he wrote.
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Indeed, no sooner were we ready to shoot off this post than Mark Arbeter, S&P;’s technical analyst, crashed into our inbox, arguing that — nope! — the correlation hasn’t broken down at all, and any continued strength in the USD could hamstring the current stock-market rally. Here’s more from Mr. Arbeter:
“Over the last year or two, the stock market and the dollar have been linked very closely. Although, sometimes an early reversal to the upside by the dollar will be ignored by stocks, and with it, an outpouring of media attention that the link is no longer valid, it has been our experience that eventually dollar strength equals equity weakness.”
The dollar’s rally can easily continue, especially once the European debt crisis shifts into high gear meaning that one of the Euro zone countries goes into default. It may take some time for this to happen but, once it does, everyone will want to own dollars, which may then very well seal the fate of equities. Only time will tell, but I will revisit that thought once we get there.
In the meantime, let the trends be your guide to any new investment decisions you are trying to make.