Idea of the day: why US indices aren’t immune to the falling dollar
City Index August 2, 2017 12:10 PM
What: As the Dow threatens to break 22,000 today after the strong set of Apple results overnight, it is easy to dismiss the decline in the dollar as a purely FX-related incident that doesn’t have any bearing on the US stock market.
What: As the Dow threatens to break 22,000 today after the strong set of Apple results overnight, it is easy to dismiss the decline in the dollar as a purely FX-related incident that doesn’t have any bearing on the US stock market. However, that is not the whole story, and the recent rise in the euro could start to impact US stocks in the coming weeks.
If you look at the S&P 500 priced in euros, see chart 1, then it has actually fallen 8% since reaching a peak back in February. It’s a similar picture for the Dow Jones, which is down 7.8% in euro terms since peaking at the start of March.
How: This can have a couple of consequences for the direction of US stocks in the coming weeks: firstly, if the euro continues to rise then returns on US equities will diminish for investors based in Europe whose $ profits from US stocks need to be converted into the single currency. This could reduce the attractiveness of US stocks for Europeans, and may eventually limit inflows into the US indices.
Secondly, on a brighter note, if you think that the euro is going to top out soon then this could make US stocks look attractive to European investors, and it may help to propel US markets to even greater highs.
Overall, as you can see in chart 2, which shows the euro and the S&P 500 normalised to show how the two move together, they have a fairly strong positive correlation. After diverging in the final quarter of 2016, the two have moved together since January. This is significant, as it shows that right now a strong euro (or a weak dollar) is not hindering the upward trajectory of the S&P 500, even though European investors’ are seeing their returns eroded by a stronger euro vs. the dollar. However, this chart is also a reminder that the two can also diverge, and at some point the FX impact, along with other factors, could be enough to break the cosy relationship between US indices and the stronger euro. This hasn’t happened yet, but don’t rule it out.
The S&P 500 priced in euro
Source: City Index and Bloomberg
Source: City Index and Bloomberg
GAIN Capital UK Limited (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.
No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.