For all the discussions about the stock market being dependent about which way the dollar is heading, have you heard any facts? I know you have heard statements by the financial “journalists” on CNBC and Bloomberg that stocks went up when the dollar went down and vice versa every day for the past few months. But those people saying something over and over again doesn’t mean that it has meaning. Of course, there is no shortage of other supposed investing gurus saying the same thing which apparently lends credibility. But once again….have they provided any facts other than saying there appears to be an inverse correlation. And as for the bloggers, there is no shortage of useless posts showing charts and correlations. Are these people just repeating what they heard on CNBC or are they actually doing some critical thinking and analysis on their own?
Listen to these brainiacs at your own risk. But please ask them for some facts or better yet….do your own fact checking.
Here are some questions you might want to dig into and after doing an analysis, if you come to a conclusion that the evidence shows a very strong statistical correlation, I encourage you to develop an investing system around it (good luck with that!) Otherwise, all this talk about being dependent upon the dollar is useless at best.
1) Please define the variables. Are you only looking at the correlation between the USD index (dollar against a basket of other currencies) and the S&P 500 index? Just saying the “dollar” goes down and “stocks” go up is a bit vague and overly simplistic. As I have mentioned repeatedly on this site, currency valuation and trading is an extremely complex subject that involves global macro factors that most people do not spend anytime understanding. Just saying “the dollar” is moronic. The dollar in this correlation argument is only a measure when it is relative to some other currency. So to buy into this generic dollar / stock concept…don’t you think you should specify exactly what the dollar means? If you want to just say the USD index, you can do that, but it certainly makes the logic behind the argument lose a ton of credibility. As for “stocks”, what does that mean? Does it just mean the S&P 500? What about vs the Willshire 5000 or the Dow 30 or the S&P Midcap and S&P Smallcap indices or the Russell 1000, 2000, and 3000. I’ll make this specific for you…have you seen any correlation studies about the dollar / stock data or just some parrot like Pisani telling you that stocks went up because the dollar went down? How about asking for the data? Or is that just too much work?
- How did the USD index do vs. the S&P500, S&P400, S&P600, Dow 30, Russell 1000, Russell 2000, Russell 3000, NYSE stocks, Nasdaq stocks, ADRs and most importantly, how did it do versus the stocks in your portfolio?
- How did the Dollar/Yen movement correlate with all those different groups of stocks? What about the Dollar/Euro? Or the Dollar/Pound or Dollar/Aussie or Dollar/Kiwi or Dollar/Franc or any other currency pair you can find?
2) Please define the period and number of datapoints. For any statistical analysis to be meaningful, it has to have a robust set of datapoints. Using whatever variables for “dollar” or “stocks” you want, try going back 10 years, Since March 2003, Since July 2007, Since September 2008, Since March 2009, and Since July 2009. To make this work, you’ll need to decide what period to use (years, months, weeks, or days). For example, if you compare the USD 10 years ago to the USD today, you will find it went from 100 in 1999 to 75 today, a 25% decline. Meanwhile the S&P was approximately 1375 in November 1999 and it is 20% lower today. HMMMM????!!!! Dollar Down 25%, Stocks Down 20%. Of course using 1 ten-year period provides almost no statistical value and whether it confirms or conflicts with today’s dollar/stock theory, it is largely irrelevant. You need to do more work. Over 10 years, I would use either 520 weeks or 120 months. For shorter time periods, please make sure you have at least 50 datapoints whether you use weeks or days and make sure that if you want to compare the performance over 10 years to the performance over the past 3 months, you must use the same variable (in this case days). Wow, that sounds like a lot of work. And it is. Do you think anyone you have heard proposing this theory as fact over the past few months has done any of this work? If you believe the theory, have you reviewed any data like I am suggesting or is that just too much work?
3) I am not going to use too many of the actual statistical terms as that gets confusing to some, but wouldn’t it be nice if the proponents of this dollar/stock theory would tell you more than “if one goes down, the other goes up”? Once they have done all the work in steps 1 and 2 above, they could answer some more questions. Wouldn’t you want to know how many days over those different time periods there was perfect inverse correlation (correlation coefficient of -1)? Furthermore, like Beta - wouldn’t you want to know what the percentage change in stocks is for every percentage change in the dollar? Let’s say you analyzed the USD vs. SP500 daily performance for every trading day over the past 2 years and found that the inverse correlation existed 59% of the days, would you find that to be a strong correlation? What if you just looked at the data since July 1st, 2009 and it showed 70% of the days were inversely correlated. If the analysis of each inverse correlation day would show that the dollar could change between either 0 to 1% or 0 to -1% and the S&P would change between .1% and 2.5% regardless of whether their was a big change (greater than .5%) or a small change (less than .5%) in the USD, would that tell you whether the correlation was useful in predicting anything or help you improve your trading decisions? Would you be disappointed if the days that did not have the inverse correlation showed almost the same performance so that for each day the dollar went up a small amount the S&P 500 could have gone up anywhere from 0 to 2.3%? And after you reconcile all that, please consider that of the 3000+ stocks I cover, it is very rare to have more than 75% going in the same direction on any given day, regardless of whether there is an inverse correlation with the dollar. Please look at the advance decline line and you’ll know what I am getting at.
4) Now for one of the key economic theories that supposedly supports this dollar/ stock concept via expected improvements in fundamentals (revenue and profits). The weak dollar proponents tell you that this makes our exports cheaper. I don’t disagree with the theory (I do have a masters degree in finance and have taught college finance). However, just stating a theory does not provide evidence of actual fact. For all the academics and economists and investment gurus and financial “journalists” and “leading bloggers”(not me!) that have droned on and on about how the weak dollar is boosting the revenues for exporting companies like big MNCs, how many have shown any actual facts? Just stating a theory is not good enough. So I suggest they or you compare the revenues of the biggest multinationals you can find. Let’s say you pay for access to Bespoke’s database of international revenues and analyze all those stocks. If this theory is so fantastic you might expect that companies with a higher percentage of international revenues would have a high percentage of revenue growth as the dollar declined. Good luck finding a correlation there. Go ahead and analyze all the S&P 500 stocks and group them into deciles of international revenue percentages. Or just pick the DOW 30 and use the 21 that have the highest international revenue percentages (about 40-80%). Then see how many of them have year over year revenue growth. Once again, over various time periods (say quarters) how many of these companies show growth during periods of a declining dollar. Okay, I know this argument gets really weak here. You should be saying that it would be virtually impossible to identify how much of a company’s total sales growth or sales declines was due to the impact of an economic theory about incremental export revenues based upon currency fluctuations. You’d be right to suggest things like the state of the economy in each foreign market, the number of competitors producing the same product and their competitive/ cost advantages, the relative quality of the product, etc. etc would affect the sales growth. I agree and that is part of my point. It is almost impossible to figure out how much incremental sales is obtained solely due to currency depreciation. So suggesting that a weak dollar is the primary reason for expectations of increased revenues and profits is similarly ridiculous and ambiguous. Oh and one more problem with this argument - it cuts both ways. US companies tend to import quite a lot of raw materials and components for these “cheap” exports we are supposedly pushing to the rest of the planet. Does anyone care to explain how increasing energy costs or metallic commodities will not offset whatever incremental sales come from weak dollar exports via reduced gross margins and operating income?
Some final thoughts…..
Things like this don’t just pop up out of nowhere for no reason. Somebody is benefiting from proposing and reinforcing this theory. I imagine the government must love the idea that it can destroy the dollar and make almost everyone feel great about how rich they are getting with stock appreciation. I imagine the High Frequency Traders love it so they can exploit this trade for as long as it lasts. But as for most traders and investors, I doubt there is anything that you can do with this concept even if it would be true. Maybe you can do all the analysis I mentioned and find which stocks have perfectly negative correlation coefficients and highly predictable percentage changes with each expected change in the dollar index. Maybe you have the ability to perfectly forecast the movement of the dollar for every second, minute, hour, day, or week and then make perfectly timed trades to get in and out. But I doubt it. Mostly, people are just buying into this hype without any detailed proof and without any way to trade it. Hopefully, in secret they are spending their time with good old-fashioned fundamental and technical analysis and ignoring currencies.
The financial media can be dangerous to your portfolios and for that matter so can bloggers. But it is up to you to filter out the real information from the spin and hype. Every day on CNBC they endeavor to give you the answer why stocks go up or down. Satisfying and entertaining their viewers seems to be their mandate. Sometimes they’ll say it was “profit taking” and other days it might be the Fed’s rate decision and other days it might be the jobs report or some other economic release. It really doesn’t matter the reason…they just want to give you an answer…any answer. And amazingly, that’s what many people want and eat up. As I have repeatedly pointed out over the years, there is no single answer. Asset pricing and the associated movements result from unbelievably complex interplays between hundreds and thousands of variables and their millions of possible permutations.
So whenever you hear something like “stocks” went up today because the “dollar” went down, please consider that not only is there no single answer…but the answers are never the same every day for 3 or 4 months and they are never that simple. Right now, the media loves this dollar / stock concept because it is easy for them. Without almost any objection, they keep saying it and while that is pathetic, it is understandable. What isn’t understandable is the vast majority of investors that seem to have accepted this concept as irrefutable without asking for or being provided with detailed data.
As I have tried to show in this post, making such a dramatic statement to explain the moves in the market carries a great responsibility. Don’t you deserve some real data or is it just too much work? Do you like easy answers?
And for the record, this is not even close to the first time I have mentioned the dangers of listening to the currency markets to explain stock movements. You might want to read my criticism about focusing on the concept that the weak dollar was great for Large Caps when it was a common argument in June of 2007. You might want to ponder why this is such a good argument now when it sucked so bad in June of 2007 and again when I wrote about it on September 24, 2008. Does it not trouble you that the same nonsense was being pushed a year ago given what ended up happening to stock prices in the five months that followed? Or after all this post’s discussion, do you just want to look at the USD index rising from October 2008 until December 2008 and then again from January 2009 to the beginning of March to explain why stocks declined? If so, I cannot help you.
Regardless of whether I find this to be BS or not, other people are focusing / obsessing on it and I certainly pay attention for that reason. However, I don’t consider what happened with the dollar on any given day or week when I decide on the signals at HEDGEfolios. I never have. If it is so important to consider the dollar movement to do well with stocks, then please evaluate how HEDGEfolios is kicking the index’s ass when I don’t analyze dollar movements.
And when this obsession with the dollar ends….you know it will end…what will investors do?