The Long, Dynamic Relationship Between The Stock Market And The Dollar

Sam Ro

 Mar. 10, 2013

Wikipedia, Jack Lew signature

The weak dollar has been seen as a key driver of the stock market recovery in recent years.

Since the early 2000s, "a weaker dollar brought higher EPS yet little inflation,"  wrote Deutsche Bank's David Bianco in a new note to clients.  "S&P foreign profits increased to 40% of total profits from 20% in late 1990s. S&P EPS benefits from a weaker dollar through FX translation and usually higher commodity prices."

But in recent weeks, the U.S. dollar and the stock market have been  moving in tandem.

And Bianco thinks this is good news.  From his note:

It would take a very sharp dollar rally to derail EPS growth or cause oil prices to collapse, which we do not expect. But gradual dollar strength, as we do expect, would be consistent with further improvement in US economy and fiscal position, which should help raise the PE. The benefits from the increased likelihood of a sustainable US up-cycle would most likely outweigh the modest EPS headwind from a stronger USD and help drive PE expansion to a more normal 15x or higher. A stronger USD will also improve foreign investor confidence and help bring inflows to US equities."

Ultimately, the stock market isn't driven by moves in the dollar alone.  Rather, their dynamic relationship is usually a reflection of something much bigger going on in the global economy and financial markets.

Here's a lightly annotated chart from Bianco. The dark blue-line reflects the correlation between the S&P 500 and the dollar.  As you can see, the relationship has been anything but static:

Deutsche Bank