Fisher Investments Editorial Staff
US Economy, Currencies

Battle of the Buck

By, 11/11/2009
 

Story Highlights:

  • The dollar's weakness may seem a valid worry, but over the long haul, neither dollar strength nor weakness determines stock prices.
  • On an annual basis since 1971, the S&P 500 and dollar moved in the same direction about 50% of the time, and their paths diverged the other 50%.

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Each day the mighty buck does battle, and for months it's been giving up ground amid concerned chatter. But exactly what drives currencies at any given moment isn't easy to fathom—and doesn't influence stock prices over the long run in any case.

 

Currencies are the biggest, deepest markets in the world. Over $3 trillion in currency- related transactions, or almost a quarter of annual US GDP, take place daily. That's a mind-bogglingly huge market. Mind-bogglingly. What were we saying again? Oh yes. How on earth does one account for movements in a market like that?

 

Take the weakening dollar. It could be that lately traders are borrowing dollars and investing them overseas in high-performing regions like emerging markets—the opposite of last fall, when investors sought safety of assets denominated in USD. Finance geeks call this the "carry trade." There's very likely some of this going on—the correlation lately between dollar direction and stock direction is almost too high to argue otherwise. But…

 

…one of the most hallowed, important, never-forget-it-or-mistakes-almost-always-ensue rules about investing is "NO CORRELATION WITHOUT CAUSATION". If you see a relationship but can't explain it, it usually leads to more trouble than good. And as far as the carry trade goes, there's a big correlation but scant hard evidence to corroborate it.

 

Maybe the "carry trade" is the big deal many think it is right now. But maybe dollar woes are more aptly rooted in demand for oil, easy monetary policy, relative expectations of US interest rates versus other major countries, or looming rampant inflation. Or some combination of all these, or something not yet articulated. Truth is, we could divine a plethora of theories that purportedly explain the dollar's movement and whether stocks are related to it—and confuse ourselves and readers in the process. Instead, we'll leave such mental wrangling (and risky, short-term investing strategies) to currency traders—because ultimately, the dollar's demise or triumph doesn't matter one whit to stocks over the long run.

 

The chart below compares the US trade-weighted dollar to the S&P 500 annually since 1971 (post-Bretton Woods currency controls). The S&P and dollar moved together about 50% of the time, and their paths diverged the other 50%. Simply flipping a coin would have been about equivalent to constant daily dollar analysis—and it'd have been a lot less painful. Even worse, and much to the chagrin of coin-flippers and dollar-diviners alike, ignoring USD altogether and passively investing in stocks would have yielded a rising portfolio 76% of the time.

 

S&P 500 vs. US Dollar: Frequency of Up and Down Years (1971-2008)

So, leave the buck to battle. It may give up more ground—but it won't tell you where stocks are headed.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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