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Thursday, April 21st, 2011
the dollar effect

Much of the interest in precious metals comes from a belief that “fiat” currencies are headed for a big crack-up and none more so than the U.S. dollar.  Even when those fears aren’t at the top of the list of concerns, we hear prognosticators talk about the dollar and what it means for various assets, including stocks.

So, here is some perspective.  The top panel shows the U.S. Dollar Index, the currency against an average of other major currencies.  The bottom panel is the Wilshire 5000, which is the broadest measure of the U.S. stock market.  For the record, the statistics show zero correlation between the two over this period.  However, the series have had a highly-positive correlation during some periods and a highly-negative one during others.

It’s tempting to talk about each bend and wiggle in these charts, but a few things stick out.  Stocks moved off of the 1974 bottom in a pretty consistent trajectory (this is a log scale, so it’s easy to spot), topped off by a tremendous acceleration in the late 1990s.  Since then, the best description is “sideways and very volatile.”

The dollar had its big hurrah in the early 1980s, but look at what it was doing during two impressive stock moves:  from 1995 to 2000, the dollar was moving steadily higher, and from 2002 to 2007, it did just the opposite.  It makes sense to take predictions about movements between the two with a grain of salt.

Which is not to say that the dollar isn’t a factor for stocks or that it won’t have a psychological impact on investors.  Sometimes we convince ourselves that dollar weakness is good and sometimes we think it’s bad.  Knowing which of those environments is in force is important, but so is remembering that one’s impressions are fickle.  (Chart:  Bloomberg terminal.)