S&P 500 Performance During Dollar Bull and Bear Markets

If you've been following the recent inverse relationship between equities and the dollar, you would think that a weak dollar has always been good for stocks.  Afterall, the most recent rally in the dollar peaked on March 5th, which was only two trading days before the S&P 500 made its bear market low.  Since then, the dollar has declined by nearly 15% while the S&P 500 has rallied by over 55%.  While the relationship looks cut and dry, the reality is that from a longer-term time perspective, US equities have tended to do better when the dollar was rallying.

The table below highlights the different performances of the S&P 500 during bull and bear markets in the US dollar index.  The average return of the S&P 500 during the five dollar bull markets has been a gain of 59.17%.  In dollar bear markets, the average return for stocks is considerably lower.  Even if we include the current dollar decline, which has yet to meet the -20% threshold for a bear market, the average return of the S&P 500 during dollar bear markets has been a gain of only 23.65%.  It wasn't until the last bull and bear market in the dollar that the S&P 500's returns shifted.  In the prior four dollar bull/bear cycles. the S&P 500 always performed either inline or worse during the dollar bear market than it did in the preceding bull.

So what caused a relationship that had been in place for several decades to suddenly reverse course?  One of the more widely discussed factors behind the reversal is the fact that the pickup in global trade has made US companies more diversified.  Therefore, as US companies generate a higher percentage of their sales outside of the US, their businesses are more impacted by changes in the US dollar.  When the dollar rises in value, goods made by US companies become less attractive (more expensive) relative to their global peers.  If the dollar falls in value, goods produced by US companies become cheaper relative to their global peers.  In this light, companies generating more than half of their sales outside of the US benefit when the dollar declines in value.

Another less discussed reason for the rising inverse correlation between equities and the dollar is that stocks are increasingly becoming commoditized in the way they are traded.  Instead of trading based on the outlook for specific companies, an increasing amount of the volume in equities is the result of investors wanting exposure to 'stocks'.  Just look at the booming popularity of ETFs which help to facilitate this trend.   As a result, like other commodities, when all else remains equal, an increase in the value of the currency they are traded in will result in lower prices, while a decline in the currency's value will result in higher prices.

No matter what the cause of the shift, it is important to be aware that on a longer-term basis, money always tends to flow where it is treated best.  In the here and now, equities may be seeing benefits from a falling dollar and getting hurt when the dollar rises.  However, in the years ahead, the US economy, and as a result equities, will be in better shape in a stable dollar environment that attracts foreign investment rather than an environment where the dollar continues to shed value and foreign investors shed the dollar.

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