US Dollar’s Influence on the Stock Market
This post was inspired by Bespoke’s Stronger Dollar and the Stock Market. Bespoke looked at the connection between the US Dollar and the S&P 500 in very broad bull/bear cycles and demonstrated that a strong dollar has been good for stocks. Here I want to take a much more active view and look at how the US Dollar Index (USDX) and S&P 500 influence each other on a daily basis.
Unfamiliar with the USDX? Read the Investopedia definition.
First off, daily changes in the USDX and S&P 500 are mostly (statistically) uncorrelated. See graph above of the rolling 1-year correlation of daily % changes from 1987 to 07/2008.
But I think the statistical measure of correlation isn’t capturing the whole story. The next graph shows the S&P 500 (blue) along with the S&P 500 when the USDX closes up for the day (green) versus down (red) since 1986.
Clearly, Bespoke’s observation that the market likes a strong dollar holds true even in the daily timeframe. When the US Dollar moves up today, it portends strong stock performance today as well.
Why didn’t the correlation statistic capture this? I need to do some more number-crunching, but off the cuff I think it has to do with the fact that this relationship is not always completely linear. A mildly strong dollar might be good for stocks, but a very strong dollar impedes growth and thus might be bad.
Is it the chicken or the egg? If the market outperforms on strong dollar days, does that mean that the dollar outperforms on strong market days? Nope. The graph below of the USDX (blue) along with the USDX when the S&P 500 closes up for the day (green) and down (red) shows the relationship is one sided: the USDX consistently influences the S&P 500, but the S&P 500′s influence on the USDX isn’t so clear.
So now for the big question: how does this impact me and my trading?
I’m approaching my self-imposed word limit so in a follow up post I’ll share my own spin on this topic…stay tuned.
Filed under: Stock Market Mechanics | 2 Comments