Investors and traders are susceptible to recency bias, which means that they emphasis recent observations over those that occurred in the past.
The U.S. Dollar has been rising recently, which reminds some investors of the 2014-2015 USD spike that led to a “significant correction” for the U.S. stock market in 2015-2016.
For starters, it’s important to put things into perspective. The U.S. Dollar’s recent “surge” is more like a small rally.
Here’s the more important point.
A more detailed look at history demonstrates that a rising and strong U.S. Dollar is not consistently bearish for the U.S. stock market. In fact, the stock market tends to go up more often than it goes down when the U.S. Dollar is rising!
Let’s look at the USD’s 3 major historical bull markets and the U.S. stock market’s (S&P 500’s) reaction.
*The S&P 500 is on a log scale.
Mid-2011 to late-2016
Mid-1995 to the end of 2001
Mid-1980 to early-1985
The U.S. Dollar went up from mid-1980 to early-1985. The correlation between the USD and S&P 500 was extremely random. Sometimes the stock market went up when the USD went up. Sometimes the stock market went down when the USD went down.
The stock market’s performance during other USD rallies
The stock market’s performance was mostly random during smaller USD rallies as well.
The USD rallied from mid-2008 to early-2009 and from late-2009 to mid-2010. The stock market crashed and swung sideways, respectively.
The USD rallied from 1988 to early-1989, early 1991, and late 1991 to early 1994. The stock market either rallied or swung sideways during these USD rallies.
A rising or strong U.S. Dollar is neither consistently bearish nor consistently bullish for the U.S. stock market. The correlation is mostly random. This suggests that U.S. stock market investors and traders shouldn’t focus too much on the U.S. dollar and currency markets when predicting the stock market’s medium-long term outlook. Correlations are of secondary importance when predicting the stock market’s future direction.
There’s a simple reason why a rising U.S. Dollar isn’t consistently bearish for stocks.
Economic theory states that ceteris paribus (all else being equal), a rising USD = less exports, which hurts U.S. GDP because it makes American exports more expensive. But ceteris paribus does not apply to the real world.
When the U.S. Dollar goes up:
- Large multi-national American companies that export to the rest of the world are hurt. Their overseas earnings shrink a little in USD terms.
- American companies that derive most of their revenues from within the U.S. actually benefit. E.g. if a retailer imports products from overseas, those imports just got CHEAPER thanks to the strong USD. That reduces costs for these companies, which boosts their corporate earnings.