How Does a Strong Dollar Affect the Stock Market

How Does a Strong Dollar Affect the Stock Market?

5 min read

How does a strong dollar affect the stock market? There’s a general correlation that when the U.S. dollar’s value rises, so do U.S. stock indexes. Over the past 20 years, there has been only a slight positive correlation with the S&P and dollar rising simultaneously 40% of the time. We’ll explinto more detail about this correlation and how this knowledge can help you with the stocks you trade going forward.

How does a strong dollar affect the stock market? The dollar can become more valuable about other currencies in two ways:

  1. Its value grows when global demand for the USD increases
  2. Its value grows when the Federal Reserve reduces the amount of currency available(which rarely happens)

These are the only two ways (so basically one). Because the U.S. dollar is required to purchase American stocks, the value of a U.S. stock index (like the S&P500) will also rise. 

However, the effect on a specific portfolio with the dollar’s movements will depend on the individual stocks that make up the portfolio. The more diversified with large-cap stocks, the more it will follow the pattern of the S&P500, but a portfolio’s constituents could be worthless or more than before.

Approximately 40% of S&P 500 Index earnings come from outside the U.S.  U.S. companies manufacturing goods in the U.S. and selling abroad have acknowledged that the dollar’s rise negatively affects their bottom line.

How Does a Strong Dollar Affect the Stock Market: Three Potential Effects

The Good

How does a strong dollar affect the stock market? Companies that export U.S. manufactured goods will do well if the U.S. dollar depreciates.  Foreign sold items will be cheaper relative to the local currency. And when converted to USD the company’s revenues are greater, making U.S.-made goods more price competitive. 

The Bad

For companies that require international imports such as fuel, raw materials, or commodities, if the USD loses value, their manufacturing costs go up dramatically, reducing profits and the company’s results.  If a company does not hedge against such dollar changes, it can be affected. A company that relies on lithium from Chili to produce its batteries will require more money to pay for the raw material.  If they keep final product prices the same, they will make less per unit sold or they must raise their prices and possibly lose customers to make the same amount. 

Goldilocks

With a diverse portfolio, including companies operating globally, this diversification will be sufficient to prevent great changes. How does a strong dollar affect the stock market? A change in the dollar will help some companies and hurt others, but the result will be nearly even, especially if the constituent companies are hedging the USD.  This indicates the importance of a diversified portfolio, and in general, the market spends more time going up along with the value of the dollar due to its general stability.

Special Situations

While the above information is important for individual stocks, the S&P500 and the U.S. Dollar index have identified some unique situations.  The DXY is a basket of the following six currencies.

How Does a Strong Dollar Affect the Stock Market

Below are some graphs of the S&P500 and the DYX over a 30 year period.  The grey highlighted areas in the first graph are when the two were moving in opposite directions (the first is in 1987).

How Does a Strong Dollar Affect the Stock Market

We notice that about half the time, they move in the same direction (the white sections) and in opposite directions in the gray areas.  This would lead us to believe there is minimal correlation, but there are a few things to know.  It is common for the DXY and the S&P500 to move in the same direction under certain circumstances. 

The following graph shows the same 30 years with the grey areas indicating when both were moving up together.  This pattern usually happens in economic recovery times. 

How Does a Strong Dollar Affect the Stock Market

These are long periods where the economy does well, and the dollar does well.

It is also much less likely that both will be moving downward at the same time.  Notice how rare this is the case…..

How Does a Strong Dollar Affect the Stock Market

If you see that they are both moving downward together, don’t expect this trend to last for a long time; the longest period was one year in 1990 during the lead-up to the first gulf war.  One will be switching upward soon; it is just not easy to know which will be moving up first, but stocks usually move up with a 10-30% rally when this turn happens. 

Currency Traders

It is worth knowing what currencies move in the same direction as the USD.

  • USD/CHF – U.S. Dollar / Swiss Franc.
  • USD/JPY – U.S. Dollar / Japanese Yen.
  • USD/CAD – U.S. Dollar / Canadian Dollar.
  • USD/RUB – US Dollar / Ruble.

And the following move in the opposite directions

  • EUR/USD – Euro / U.S. Dollar.
  • GBP/USD – Pound / US Dollar.
  • AUD/USD – Australian Dollar / U.S. Dollar.
  • NZD/USD – New Zealand Dollar / U.S. Dollar.

Final Thoughts: How Does a Strong Dollar Affect the Stock Market

How does a strong dollar affect the stock market? Being diversified and with companies selling globally, the S&P500 won’t be significantly affected by the movements of the USD. We can benefit from this knowledge in that strengthening the dollar will affect certain companies that rely on dollar imports.

Meanwhile, exporters will be helped if the dollar is down and the USD and stock markets move in the same direction under some circumstances. Usually, upward movements are longer in duration than downward movements. Knowing what currencies move in the same direction as the USD will also help currency traders. 

As always, never put yourself at risk with one position more than you’re willing to lose, and good luck with all your trades.

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