There is a tremendous amount of commentary regarding the recent drop in the dollar and whether it is fundamentally good or bad for stocks. Rather than weigh in on this side of the debate (like you need another voice anyway), we would like to look at how the US Dollar Index (USD) has acted going into the Dubai G7 meeting, psychology at financial market turns and what happens to stocks and bonds after a 15%+ drop in the USD.
For those pressed on time, the USD already made its low in May after a 22% drop, markets typically do not crater when everyone is talking about it, and each 15%+ drop in the USD was followed by a significant rally in stocks and bonds - Thank you for reading and if you want to see the above points graphically move on from here.
Major US Dollar Index Drops. The USD had dropped by more than 15% three times prior to the most recent low in May 2003. The average drop was slightly greater than 19% over 16 months (Exhibit 1).
Stock and Bond Reaction to Dollar Drop. The fundamental debate may be raging on the ultimate impact a declining US currency may have on the financial markets, but historically there is no debate. Each time the USD dropped by more than 15% and bottomed, the SPX rallied over the following 3, 6, 12 and 24 month periods (Exhibit 2). In addition, each low in the USD corresponded with a drop in the 10-year Note yield (Exhibit 3). We are using monthly data provided by Baseline Inc, and calling May 2003 as the fourth low after a greater than 15% decline.
Exhibit 2 - Stocks don't fall AFTER a significant decline in the USD
Exhibit 3 - Bond yields dropped after a meaningful low in the USD.
Long-term Impact on S&P Groups After USD Bottom. Rather than speculate on how various groups act following pronounced USD weakness, we would like to let performance speak for itself. The table below highlights the groups that outperformed the SPX two years after the initial USD low.
All Graphs and price data courtesy of Baseline Inc.
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