How a Weak Dollar Moves Stocks

10/22/2007 12:00 am EST

Focus: GLOBAL

Sam Stovall

Chief Investment Strategist, CFRA Research

Sam Stovall, chief equity strategist for Standard & Poor's, says that the dollar is likely to fall further and he traces how that has impacted stocks in the past.

Through the end of September, the value of the US dollar versus a trade-weighted basket of foreign currencies closed near 77 (a discount of 23% to 100, or parity, with the basket).

This represented a six percentage-point fall from the 83 level at the end of 2006, and equaled the forecasted average value of the dollar for all of 2007, according to Standard & Poor's chief economist David Wyss. He predicts the dollar will fall further in the year ahead, averaging 71 in 2008, and bottoming at 68 in 2011.

For American tourists venturing abroad, the falling dollar is not good news. For US exporters, however, it is very good news. Indeed, Wyss expects US exports to rise 9.5% in 2008, as compared with the projected gain of 7.3% in 2007. This could aid earnings for US multinationals that don't hedge their currency exposure.

Specifically, S&P estimates that 45% of 2006 sales for companies in the S&P 500 came from overseas. This figure is up substantially from the 32% estimated in 2001. Not surprisingly, investors might wonder if the price changes of these standout sectors were helped or hurt by a falling dollar. In other words, have the S&P 500 and its sectors and industries showed any strong correlation with movements in the dollar?

Since December 31, 1989, the dollar and the S&P 500 had almost no correlation over this extended period of time. [But during] five periods over the past 17 years of identifiable weakness in the dollar, the market's rise was at least partly explained by the dollar's weakness, in our view.

The correlation between monthly performances for S&P 500 sectors and the dollar since 1990 were highest for financials and consumer discretionary (indicating a slightly positive correlation with the dollar-meaning as the dollar fell, so did they) and lowest for energy. Surprisingly, however, was information technology's relatively high correlation, in light of its large overseas revenue exposure.

One might think that dollar weakness usually coincided with falling interest rates, yet two of the five periods [of dollar weakness] observed occurred during Fed rate-tightening cycles: from December 1993 to April 1995 [and] from June 2004 through June 2006.

We think there are three takeaways from this study:

1. The interrelationship of global economies and equity markets evolves continuously.

2. There are many factors that affect share prices. There was almost no correlation between the US dollar and the S&P 500 from 1990-2007. In the long run, we recommend that investors focus more on fundamental improvements and less on trying to anticipate which one will benefit from changes in the value of the dollar.

3. Should the dollar continue to weaken, and history repeats itself, the greatest share-price opportunities may be found in the S&P 500 energy, utility, and materials sectors.

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