Stocks Strong or Dollar Down?

by: Alan Brochstein, CFA

Is it just me, or does it seem like the dollar and the S&P 500 are perfectly correlated? Here is what it looks like since the rally started on July 1st (with fits and starts, click to enlarge):

EuroSPX 7-1 to 9-24

I don't fancy myself to be a currency forecaster at all - I just try to look out for big changes or the turn. Most of the time, it doesn't matter - it's only when it breaks a key level that it usually really matters. Over the past couple of years, the Dollar/Euro has traded in a pretty wide band, and we are in the middle currently (click to enlarge):

Euro 2yr

While it might seem like the weaker dollar is good for stocks, it isn't always the case. Let's take a look at the past 15 months or so. The market consolidated its new rally last summer briefly before taking off after the 4th of July in a rally that ran straight through to mid-January. We had a brief pullback that didn't qualify as a correction over the next few weeks before a rally to the April highs. That was followed by a correction to the 7/1 low. Let's see how those stock moves correlate with the Dollar/Euro movement (click to enlarge):

EuroSPX 7-8-09 to 1-19

Here, the Dollar weakened for most of the rally, but there was a divergence near the end of 2009. The Euro weakened, but stocks kept rallying. I think the issue here is that the Dollar hit an extreme in early December and the market was probably relieved to see it quit weakening. Further weakening might have been viewed as inflationary - too much of a good thing. Let's look at the brief retreat in stocks (click to enlarge):

EuroSPX 1-19 to 2-05

Here, we see the correlation reemerge - stocks didn't like that the Dollar kept strengthening. Let's look at the rally to the 2010 high (click to enlarge):

EuroSPX 2-5 to 4-26

This was a clear divergence from the correlations that have taken place since Q1-09: The Dollar strengthened modestly while stocks flew. The peak to the 2010 low looked like this (click to enlarge):

EuroSPX 4-26 to 7-1

Here, the Dollar strength was extreme again, and stocks paid the price. Notice, though, the divergence in the month of June. Stocks kept falling, though the Dollar started to weaken. This was something that had caught my attention and made me prematurely bullish. It wasn't until the Dollar gave the "all clear" signal in July that stocks turned around.

So, for now it looks like the Euro dynamic is friendly, at least till we get to 1.45 or so. I don't have any sort of crystal ball, but I do see yet again a potential opportunity to reallocate between stocks with heavy international exposure (which have been strong of late, not surprisingly) and those with more of a domestic focus. If the Dollar keeps weakening, the internationally-challenged stocks might catch up, and they certainly are likely to make up lost ground if the currency move reverses.

The market rally started right at the beginning of Q3, so looking at QTD returns is useful. Financials are very weak, up just 6% compared to the S&P 500's return in excess of 11%. On the other hand, Materials (up 19+%) and Industrials (up 14+%) are reaping the benefits of the weaker dollar. It's actually more interesting, though, to look at leading stocks within some of the sectors to see how they have performed.

Starting with Consumer Staples in the S&P 500, here are some QTD returns of the top 5 and the bottom 5:

  • Archer Daniels (NYSE:ADM): +25%
  • Philip Morris (NYSE:PM): +22%
  • Avon (NYSE:AVP): +22%
  • Altria (NYSE:MO): +20%
  • Coca-Cola (NYSE:KO): +17%


  • Conagra (NYSE:CAG): -7%
  • Dr Pepper Snapple (NYSE:DPS): -7%
  • Tyson Foods (NYSE:TSN): -5%
  • Dean Foods (NYSE:DF): -3%
  • Sara Lee (SLE): -2%

The winners have big international exposure, while the losers generally don't. KO vs DPS says it all.

Now, let's do the same exercise with Industrials:

  • Cummins (NYSE:CMI): +40%
  • Caterpillar (NYSE:CAT): +33%
  • Expeditors (NASDAQ:EXPD): +32%
  • Deere (NYSE:DE): +31%
  • First Solar (NASDAQ:FSLR): +29%


  • Quanta Services (NYSE:PWR): -9%
  • Raytheon (NYSE:RTN): -5%
  • Pitney Bowes (NYSE:PBI): -4%
  • Iron Mountain (NYSE:IRM): -3%
  • Lockheed Martin (NYSE:LMT): -2%

The winners, and they are big winners, have massive international exposure, especially FSLR. The losers don't.

So, I ask the question: Should an 8% move in the Dollar relative to the Euro engender a 24% move between KO and DPS? I think not - I am in the process of reducing exposure to KO for another Consumer Staples company that offers a higher dividend, lower PE and similar balance sheet in my Conservative Growth/Balanced Model Portfolio. If you are interested in my thinking, I explain that trade as well as a similar trade that gets a highly domestic Industrial into the portfolio. What about CMI relative to PBI - should they be moving this disparately? Or, are we seeing the macro monkeys at work here?

Disclosure: Long KO in model portfolio