The Evolving Relationship Between the Dollar and the Market: Long the US Dollar Up ETF

 |  Includes: SPY, UUP
by: Hedge Fund Live

A couple days ago we took a long position in UUP, the PowerShares US Dollar ETF, which led me to look further into the relationship between the US dollar and the equities market. I had been seeing a pretty clear inverse correlation between the two (stocks were up on days when the dollar was lower and vice versa). Below is a chart of the S&P and the Dollar Index since January 1990:

Click to enlarge
(Click to enlarge)

You can see that though we have recently seen a clear negative correlation between the S&P and the dollar, that was not necessarily the case in the '90s. When I quickly ran a search on the correlation between the dollar and the market, I actually came across mixed results with some stating that the two move somewhat together in the same direction while others expressed that there was an inverse relationship.

My chart below, which summarizes the rough correlation calculations across different time periods, points to the reason for the discrepancy in views:

From an overall longer term perspective, the correlation between the S&P and the US dollar is actually positive (about 0.16 since 1990 to present). However, going back to my initial note that the two seem to be inversely related, the data is skewed here. It appears from the first graph as well as the second chart above that the market and the dollar were more proportionally related in the '90s. Hence, calculating the correlation between 1990-2000 yields a positive correlation of roughly 0.68, which is a pretty strong coefficient.

Now examine the more recent past decade. From 2000-2010, the correlation has been -0.04, entering the negative territory now. To show that we have been seeing an increasingly negative correlation, I broke the past decade down even further. In the past five years from 2005-2010, the correlation between the two has been -0.22. Finally, since 2009 to present, the correlation coefficient has become even greater on the negative side: -0.42.

Not to get too obsessive over honing in on the inverse relationship, but for kicks I checked out the correlation since the April highs of this year: -0.54; and now for the correlation in the past 60 trading days: -0.93. That is almost perfectly inversely correlated! So it is pretty evident that we have been seeing the prices of the S&P and USD diverging to an increasingly larger extent in recent years.

Since I believe the market is very soon due for a small pull back, I like the long UUP trade that we recently put on, as this analysis suggests that when the market pulls in, the dollar goes up.

Disclosure: Author long UUP