Friday, January 8, 2010

This Correlation Still Exists

As you all know, there has been a tight correlation between the US Dollar Index and equities for the better part of 9 months. If the Dollar goes down, then equities go up. Even if there is a hint that the Dollar might go down - let's say, a bad employment report suggesting that the Fed will keep its foot on the monetary pedal even longer- stocks go up. We all have the drill down. The Fed throws us a biscuit, and we all stand up and bark!

Since the Dollar has started to show signs of reversing its down trend, several market commentators have remarked that how resilient stocks have been in the face of a rising Dollar, and some have suggested that the correlation between the Dollar and equities has been broken.

I say not so fast. See figure 1 a 60 minute bar chart comparing the Power Shares QQQ Trust Series (symbol: QQQQ) in the upper panel with the Power Shares DB US Dollar Bull (symbol: UUP) in the lower panel. Going back to mid - October, the correlation is pretty easy to see - Dollar down, stocks up. Starting in December, the Dollar broke its down trend (gray oval on chart), and stocks went sideways. This is a plus for stocks as the Dollar was up and stocks held their ground.

Figure 1. QQQQ v. UUP/ 60 minute

Now look to the upper right on the chart. These gray rectangles depict the last two weeks of trading. The relationship of Dollar down and stocks up still appears to be holding true to form as the Dollar is at the lower end of its range and stocks are at the upper end.

I see no evidence that the correlation between the Dollar and stocks has been broken. Although it is all stocks all the time for most people, it is no secret that I am not buying the hype of this rally although I do have exposure to various sectors that I have mentioned in this blog including regional banks, utilities, housing, Japan, and Canada. With shares so overbought and sentiment overdone and headwinds mounting, there are heightened risks although most investors believe that the government and Federal reserve have back stopped the market and taken risk out of the equation. Nonetheless, there is good reason to believe (and I have to yet to present the data) that the Dollar could rise, and as this correlation between stocks and the Dollar still exists, this would pressure equities.

Regardless what you think, this relationship between the Dollar and equities bears watching.


D-man said...

such a thing named "correction" doesn't exist :)

Guy M. Lerner said...

it is funny but the best thing that could happen to the bulls is a correction

I want the market to go up just like everyone else; I am not a curmudgeon or negative by nature, but a correction would really be helpful to produce a "healthier" market

Anonymous said...

maybe you should plot UDN and one of the indices...say SPX. The correlation broke in december09. So now the MMs (the gov/fed/banksters) can have their cake and eat it too. Dollar up
Dollar up

How F'n convenient